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1 Visit SOFE at: www.sofe.org Spring 2013

Examiner® Volume 38Number 1

Spring 2013

Official Publication of the Society of Financial Examiners®

®


Examiner®

Volume 38 | Number 1 | Spring 2013ISSN 0190-2733

IN THIS ISSUE

7 Supervisory Colleges by Shawn Towchik, LeeAnne Creevy, and Jan Moenck

13 Corporate Governance Guidelines by Jim Stangroom

19 Overview of HIPPA Omnibus Final Rule by Denise Mainquist

22 Skills of an Effective Insurance Examiner by Joanne Smith and John Humphries

29 Insurance and Behavioral Economics by Howard Kunreuther and Mark Pauly

34 NAIC Fall 2012 Meeting Notes

Articles in The Examiner reflect the views of the individual authors and do not necessarily represent the official position or views of the Society of Financial Examiners nor any state or federal agency.

Publisher Society of Financial Examiners® 12100 Sunset Hills Road | Suite 130 Reston, Virginia 20190 703.234.4140 800.787.SOFE (7633) Fax 703.435.4390

Society Executive Committee Ryan Havick, CFE | President Eric Dercher, CFE | TreasurerAnnette Knief, CFE | Secretary

Immediate Past PresidentMichael Dinius, CFE

Vice PresidentsJoanne Campanelli CFERichard Foster, CFEJenny Jeffers, CISA, AESJames Kattman, CFEWanda LaPrath, CFEMark Murphy, CFERichard Nelson, CFEColette Hogan Sawyer, CFE, CPMEli Snowbarger, CFEWilliam Umbaugh, CFE ,AESVirginia West, CFE

Legal Counsel Pro Bono William D. Latza, Esq.

Executive Director L. Brackett

Editorial and Publications CommitteeJenny Jeffers, CISA, AES, ChairLewis D. Bivona, Jr., AFE, CPATammy GavinDarlene Lenhart-Schaeffer, CFEJan Moenek, CFE, CRP, CIA, CBA, FLMIRobert H. Moore, CFEP. Sean O’Donnell, CFE, CPAJoanne Smith

© Society of Financial Examiners


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Supervisory Colleges: Considerations for the Financial Examiner and Adding Value True or False Questions — Submit Answers Online

1. Supervisory colleges are held only for insurance groups that have both Life and P&C entities.

2. The chairman of the Supervisory College is responsible for proposing the agenda for the meetings.

3. Company management is not invited to attend any of the Supervisory College meetings.

4. Examiners can assist in preparation for a Supervisory College meeting by preparing documents to share such as prospective risk summaries, corporate governance assessments, lists of key findings and exam adjustments, key reports used by management to mitigate risks, etc.

Corporate Governance Guidelines, Principles and Implications for Examiners True or False Questions — Submit Answers Online

1. The Examiners Handbook does an excellent job in dictating what an insurer’s management oversight, corporate governance and internal control structure or documentation should include.

2. The Corporate Governance Working Group suggests additional guidance to Exhibit M.

3. Exhibit M now provides guidance on assessing the Board of Directors and in the future will provide guidance on assessing the competence of management.

4. The International Association of Insurance Supervisors (IAS) has a framework of 26 Insurance Core Principles (ICP) as guidance for global regulators. In 2014 the U.S. will be evaluated by the International Monetary Fund.

CRE READING PROGRAM

QUESTIONSAll quizzes MUST be taken online

continued on page 5


Overview of HIPPA Omnibus Final Rule True or False Questions — Submit Answers Online

1. Since the HITECH Interim Final Rule was implemented in September 2009, it was found that 1 in 10 breaches were cause by a Business Associates.

2. Prior to the HIPAA Omnibus Final Rule Business Associates were regulated by each states insurance department.

3. The HITECH Breach Notification rule expanded the definition of breach to include “unauthorized acquisition, access, use or disclosure of protected health information which compromises the security or privacy of such information.”

4. The final rule requires that the Secretary of HHS conduct a compliance review where an initial review indicates the covered entity or business associate performed a violation due to “willful neglect”.

Skills of an Effective Insurance Examiner True or False Questions — Submit Answers Online

1. An effective insurance examiner utilizes the NAIC Financial Condition Examiners Handbook as a key source of regulatory knowledge.

2. Effective examiners focus on the most important and high-risk exam areas first.

3. Examiners protect confidential and sensitive data received during examinations by ensuring physical and logical security.

4. Computer Aided Audit Techniques create additional manual work for examiners when testing large data files for regulatory compliance.

CRE READING PROGRAM

QUESTIONS(continued)

All quizzes MUST be taken online

continued on page 6


Insurance and Behavioral Economics: Improving Decisions in the Most Misunderstood Industry True or False Questions — Submit Answers Online

1. Most homeowners do not buy flood insurance because they do not perceive value according to the authors.

2. Insurers tend to view low probability losses as improbable and therefore tend not to explicitly mention or price for the risk in the policy.

3. Multiyear policies, while higher cost, would provide better price stability and encourage policyholders to invest in protective measures.

4. Means testing and vouchers would not be a good way to address low-income consumers’ availability to CAT coverage.

CRE READING PROGRAM

QUESTIONS(continued)

All quizzes MUST be taken online


continued on page 8

Supervisory Colleges: Considerations for the

Financial Examiner and Adding Value

By: Shawn Towchik, Jan Moenck, and

LeeAnne Creevy

Overview of the Supervisory College ProcessThe current insurance marketplace crosses multiple borders which has fueled the creation of multinational insurance holding companies. As a result, the increased utilization of Supervisory Colleges for group supervision has become more critical.

The International Association of Insurance Supervisors (IAIS) defines a super-visory college as “A forum for cooperation and communication between the involved supervisors established for the fundamental purpose of facilitating the effectiveness of supervision of entities which belong to an insurance group; facilitating both the supervision of the group as a whole on a group-wide basis and improving the legal entity supervision of the entities within the insurance group. (Source: http://www.iaisweb.org)

The NAIC supports the increased use of Supervisory Colleges and has devel-oped a web-based request form that allows for international regulators to be able to request the participation of domestic insurance departments. Addi-tionally, the NAIC has created a Supervisory Tracking document to monitor the activity of Supervisory Colleges. (Source: http://www.naic.org)

One of the challenges that domestic insurance departments face today is the coordination of activities with other insurance departments within the U.S. for domestic insurance holding companies. Add in foreign regulators, and now the issue is further magnified. The supervision of large multinational insurance groups requires more than just local supervision of the domestic entities within the group. Supervisory Colleges are an avenue in which infor-mation can be shared with multiple parties on a coordinated basis.

For anyone who is new to Supervisory Colleges, a great reference that covers multiple aspects of the Supervisory Colleges is the IAIS Insurance Core Prin-ciples (ICP) 25, “Supervisory Cooperation and Coordination.” Throughout ICP 25, you will notice two key terms referenced the majority of the time—coop-erate and coordinate. Simply put, without either one, Supervisory Colleges will not be nearly as effective.

According to ICP 25.1.13, the primary purpose of a Supervisory College is to discuss supervisory issues and exchange information that is relevant to a group focusing on the following:

• Agree on the cooperation and coordination process including the planning and setting of procedures for supervisory cooperation during emergency situations;

• Produce an overview of the group, setting out its formal and operational structure;

http://www.iaisweb.org/index.cfm?pageID=47&vSearchLetter=s

https://eapps.naic.org/ISCR/index.do

http://www.naic.org/cipr_topics/topic_supervisory_college.htm


• Carry out a risk analysis on a group-wide basis, identifying the most rel-evant entities and the most important relationships in the group;

• Discuss issues supervisors have found within the entities they supervise that they believe could be systemic throughout the group;

• Where practicable, agree on areas of supervisory work to avoid unneces-sary duplication; possible joint inspections could also be decided;

• Agree on the information supervisors should gather from the group and exchange with other members of the supervisory college, including the form and the frequency with which this happens; and

• Agree on whether the Supervisory College should set out any arrange-ments in respect of group-wide supervision in written form (bilateral or multilateral agreements).

Effective communication among regulators is the key to a successful Super-visory College because without this level of communication, the focus items mentioned above may result in ineffective supervision. The chairman of the Supervisory College has a major role to play in the Supervisory College since he/she is responsible for proposing the agenda for the meetings (ICP 25.4.11) that incorporates the views and opinions of other members. In order to achieve this task, the chairman needs to communicate with the other mem-bers to find out what their concerns are in relation to the group. ICP 25.4.12 indicates that “Supervisory College meetings should be planned with clar-ity of the outcomes that are being sought and, based on this, should clearly record the outcomes that are achieved”. Without adequate and effective planning and communication, the outcome may be more heaving weighted toward that of the organizer.

Supervisory College meetings should function to allow members of the Supervisory College to fully understand the major risks to which the group is subject (ICP 25.5.1). According to ICP 25.6.15, the key functions of a Super-visory College includes a supervisory review of the group’s own risk and sol-vency assessment (ORSA), transparency of the group structure and suitability of the group’s senior management and its independent board of directors. The review may also cover capital adequacy, large intra-group transactions and exposures, corporate governance (including risk management and internal controls), group crisis management arrangements and review of the effectiveness of these functions. It is also important to have a group-wide understanding of how key management decisions are vetted and agreed upon and how enterprise risk management (ERM) frameworks and inter-nal models are established and operated to complement legal entity level supervision of the entities within the group (ICP 25.6.20). Domestic insurance

continued on page 9


Financial Examiner and Adding Value (continued)


regulators can provide a significant amount of subject matter as a result of the output from risk focused examinations. Prospective and financial report-ing risk summaries (e.g., “dashboard” reports) and corporate governance assessments are some materials that can have been shared prior to or during the Supervisory College meeting to provide foreign regulators greater insight into the group’s management and operations. Going forward, Company ORSA and Form F (ERM) filings, or excerpts thereof, will also be an excellent resource for Supervisory College discussions.

Trust is another critical aspect of a successful Supervisory College. According to ICP 25.5.18, each member is expected to make every reasonable effort to cooperate and coordinate in a spirit of mutual trust to ensure the protection of confidential information shared and to avoid unwarranted supervisory duplication and unnecessary supervisory burden for both the insurers and members involved. If proper communication occurs, there should be no trust issues as any areas of concern should be vetted prior to the meetings. As information is shared and exchanged in a secure and controlled environment, it both requires and encourages mutual trust (ICP 25.6.17).

Insurance company management is invited to the open sessions of the Supervisory College meetings which provide the Supervisory College mem-bers an opportunity to discuss any group level concerns with management

directly (ICP 25.6.24). This forum allows management to speak directly about the company’s business strategy, changes in senior officers, ERM, etc., at a group-wide level. It is up to the members of the Supervisory College to make the most of each meeting which means asking the compa-nies to provide specific details regarding the areas that are critical to the concerns of the members. In some Supervi-

sory College meetings, the companies have come in and presented the same (or similar) information that is shared with the rating agencies or provided to the SEC regarding financial information. Although this type of information can be great information to obtain, Supervisory Colleges should be utilized to get the critical information directly from the companies, including informa-tion about significant and emerging prospective risks, the company’s corpo-rate governance environment, and its “tone at the top.” The agendas should be structured to allow for the proper information (both the right material and the right level of detail) to be shared by the company’s senior management. Domestic regulators can play a key role in developing the agenda for the companies considering the key reports/documents that are vetted during the risk-focused examinations. Communication with the chairman of the Super-visory College is important to provide for the knowledge transfer to allow for the company’s management to be adequately prepared for the meetings.

This forum allows management to speak directly about the company’s business

strategy, changes in senior officers, ERM, etc., at a group-wide level.



continued on page 10


As an example, an insurer that is the subject of the meeting could present its most significant or “top risk” listing, which is a consolidated view of risk derived from various risk assessments and other assurance activities. This is great high level information to receive; however, in some cases a deeper dive is necessary to fully understand the information contained in the risk report. The domestic regulator, as a result of a recent risk-focused examina-tion, would know the names of the key reports to provide for a deeper dive into each of the areas referenced in the risk listing. As a result, this insider knowledge could foster deeper conversations with management regarding issues or risk areas within the group. A domestic regulator also would have an indication as to which risks on the top risk listing may not be as critical to regulators, allowing for the majority of the time with the company’s manage-ment to be more focused solely on the risks or areas of concern identified by the members of the Supervisory College. Simply put, this type of knowledge and planning will help steer the meeting toward the highest areas of interest for the regulators.

Preparing for a Supervisory College—How the Examiner Can AssistIf a Supervisory College is occurring during or shortly after the examination, examiners may be called upon to assist in the preparation of documents for the Supervisory College. As mentioned above, prospective risk summaries/

dashboards and corporate governance assessments are a great place to start. If you have significant findings or exam adjustments, these are something the participants might be interested in. Other key documents that may be helpful would be key reports that management uses to manage/

monitor prospective and/or key financial risks, the Company’s strategic plan, a listing of what the Company considers to be its key risks, etc. As Form F (ERM) and ORSA become commonly used regulatory tools it is expected that they will play a key role in Supervisory College discussions as well.

When preparing these documents, it is important to understand who the audience will be and the stature of the company as part of the group as a whole, and then prepare materials accordingly. If the company you have examined is one of the lead companies in the group, you may want to pre-pare significant amounts of information and supporting documentation; however, if the company is immaterial to the group as a whole you may want to contain your documentation to high level critical information.

Another thing you may be asked to do to prepare for a Supervisory College is to host an examiner from one of the countries involved in the group super-vision. This occurred on one of the exams that we were working on shortly before the Supervisory College. The examiner joined us on the exam, and we walked him through the prospective and financial reporting risk matri-




It is important to understand who the audience will be and the stature of the

company as part of the group as a whole.




ces, the corporate governance assessment, the Company’s ERM results, our exam approach, etc. This helped him better understand the risks facing the Company under examination, and allowed him to better understand the risk-focused examination methodology.

Utilizing Information Obtained from a Supervisory College in the ExamPerhaps the Supervisory College will occur either shortly before, or during, your examination. If that is the case, even if you do not attend the Supervi-sory College personally, you should obtain information that was distributed in the Supervisory College for consideration in your exam. This information should be reviewed, along with the rest of the documents considered in Phase 1 to identify significant risks facing the Company, including key risks at the holding company level which may present risk to the Company under examination. If the Supervisory College occurs in the middle of the exam, the examiner should consider risks identified, and modify examination planning as necessary.

ConclusionPreparing for the Supervisory College is just as important as conducting the meeting itself. Without proper preparation for the Supervisory College, the risk exists that it may become “just another meeting” (similar to when compa-nies visit the insurance department periodically). In this were to occur, there may be a significant missed opportunity to truly accomplish the objectives of a Supervisory College. Instead, if all of the members of a Supervisory College take to heart the two key terms mentioned throughout ICP 25—cooperate and coordinate—then the Supervisory College meetings will be beneficial to all of the parties involved and will contribute in a much more meaning-ful capacity to effective group supervision and an effective risk surveillance process.

About the AuthorsShawn Towchik is a Director at Risk & Regulatory Consulting, LLC (RRC) and holds the CFE designation. He is a member of the SOFE Board of Governors and has been a member of the SOFE Professional Standards Committee for the past two years. Shawn has over 13 years of experience in insurance regulation of which 7.5 years was spent as a Financial Examiner for the Texas Department of Insurance.

Jan Moenck, a Partner in Risk & Regulatory Consulting’s (RRC) Minneapolis, Minnesota office has over 25 years of experience providing examination and internal audit services to clients in the financial services industry. For over 15 years, Jan served as the lead engagement manager working with the Min-



nesota Department of Commerce, Insurance Division (Minnesota) by provid-ing co-sourced financial examination services. Jan assisted Minnesota in the development and deployment of its risk-focused examination process and has served as the Examiner in Charge on risk-focused financial examinations for over twelve years. Jan has also provided hands-on and classroom training on risk-based examination techniques to several states, the Society of Finan-cial Examiners (SOFE), and RRC employees.

LeeAnne Creevy, a Partner in Risk & Regulatory Consulting’s (RRC) Hartford, Connecticut office, has over 18 years of professional experience. LeeAnne has participated in leadership roles on a number of risk-focused financial and information technology (IT) examinations as well as operational/internal con-trols reviews. This experience includes serving as a subject matter resource on several large insurance company risk-focused examinations related to the assessment of corporate governance, enterprise risk management (ERM) and internal audit functions, and risks and controls documentation. LeeAnne has also helped to lead the RRC team’s development and enhancement of risk-focused examination methodology, including developing a “toolkit” with practical “hands on” guidance and resources. In addition, LeeAnne leads RRC’s team of IT resources dedicated to insurance regulatory examinations and has led the team in developing methodology and approaches on IT risk-focused examinations.





Corporate Governance

Guidelines, Principles and Implications for

ExaminersBy: James E. Stangroom, CPA

Corporate governance practices are an important aspect of an insurer’s over-all risk management framework. Corporate governance involves the over-sight by the Board of Directors and senior management of an insurer’s risk management, including the identification of risk, the establishment of risk limits and risk monitoring procedures, and the implementation of policies, controls and risk mitigation strategies. The assessment of an insurer’s corpo-rate governance practices is one of the most critical aspects of the regulatory risk-focused surveillance cycle, and in particular, of a risk-focused financial examination.

NAIC Corporate Governance Working Group PrinciplesBoth U.S and international insurance regulators have been busy in recent years evaluating regulatory requirements over corporate governance prin-ciples. The NAIC’s Corporate Governance Working Group is charged with outlining corporate governance principles for use in U.S. insurance regulation and developing regulatory guidance. In connection with these charges, the Working Group released a paper entitled Existing U.S. Corporate Governance Requirements, which was formally adopted by the NAIC in December 2011. Then, in August 2012, the Working Group exposed for public comment a follow-on paper that compared U.S. corporate governance standards with international standards, identified insurance company best practices and proposed certain regulatory enhancements. The Working Group plans to finalize its response to this comparative analysis of U.S. corporate governance requirements in the Spring of 2013. The regulatory enhancements being proposed by the Corporate Governance Working Group are categorized into seven Principles.

Principle 1: Regulatory reporting, disclosure and transparency – Recom-mendations include confidential insurance company filings of their corporate governance practices and revising the Model Audit Rule to require certain size insurers to maintain an internal audit function.

Principle 2: Off-site monitoring and analysis – Recommendations include expanding guidance in the Financial Analysis Handbook regarding corporate governance and holding company analysis. In addition, the Working Group is proposing a long-term project to enhance the regulatory review and assess-ment of corporate governance performed in the state level financial examina-tion and financial analysis processes through the development of a common corporate governance assessment methodology.

Principle 3: On-site risk-focused exams – In addition to recommending the common corporate governance assessment methodology referred to above, proposed enhancements include additional guidance in the Financial Condi-tion Examiners Handbook (Examiners Handbook) on corporate governance,



risk management and internal controls. Such guidance would incorporate certain elements of the International Association of Insurance Supervisors’ Insurance Core Principles.

Principle 4: Reserves, capital adequacy and solvency – Proposals include a requirement for the appointed life actuary to annually present the actuarial report to the insurer’s Board of Directors.

Principle 5: Regulatory control of significant, broad-based risk-related trans-actions – This principle recognizes that certain significant transactions require regulatory approval. Proposed enhancements include disclosure of the Board’s role in the oversight of an insurer’s reinsurance strategy, risk manage-ment and compliance.

Principle 6: Preventive and corrective measures – This principle recognizes that regulators have the authority to take timely corrective action to cause insurers to address any corporate governance deficiencies identified. Rec-ommendations include recognizing this authority as a critical element for accreditation purposes.

Principle 7: Exiting the market and receivership – This principle emphasizes that Boards of Directors of large groups have a responsibility for oversight of affiliate relationships and should take action to reduce the potential risk and impact on an insurance entity resulting from an affiliate’s failure. Recommen-dations include developing guidance for examiners to use when considering such Board oversight.

As referred to in Principles 2 and 3 above, the Corporate Governance Working Group has drafted referrals to the NAIC’s Financial Analysis Handbook Work-ing Group and the Financial Examiners Handbook Technical Group asking both groups to collaborate on developing a common corporate governance assessment methodology, including related Analysis and Examiners Hand-book guidance. The Corporate Governance Working Group made several specific suggestions for the Handbook groups to consider, including:

• The development of separate assessment categories to address areas such as the Board of Directors, organizational structure, management, ethics, compensation, strategy and risk management.

• The development of a common format to document and continually update the corporate governance assessment.

• Guidance on how the assessments can be used for regulatory surveillance prioritization and incorporated into the Insurer Profile Summary and/or Supervisory Plan.



Examiners (continued)



Industry groups and other interested parties have expressed concerns over the potential for examiners and analysts to take a checklist or template approach to assessing and grading the effectiveness of corporate governance at any company. The primary industry concern appears to be that such a standardized approach may not recognize that one size does not fit all and that effective governance practices can, and should, vary from company to company depending on a variety of factors, including size and complexity.

The Corporate Governance Working Group is also proposing that regula-tors receive more regular and timely information on corporate governance practices of insurers through the filing of a confidential supplement on insurer governance practices with the domestic state of each insurance legal entity. Acknowledging that governance practices can vary significantly from company to company based upon the size, type, complexity and structure of a company, the Working Group has proposed that these confidential filings include five broad areas:

• A general description of the insurer’s corporate governance framework, including the oversight responsibilities of the Board.

• A description of Board and committee policies and practices, including the composition of the Board and committees and how an appropriate level of independence is maintained by the Board.

• A discussion of any changes in corporate governance practices from the prior year.

• A description of management policies and practices, including compensa-tion practices and the suitability of officers and other key persons in posi-tions involving internal control functions.

• A description of the processes by which the Board and senior management provide oversight to the insurer’s critical risk areas and business activities.

Industry groups and other interested parties have expressed concerns over how confidentiality will be maintained and that such an additional regulatory filing might be duplicative and overly burdensome.

The Corporate Governance Working Group will be continuing its deliberations into 2013. Regulators have a desire to gain an even better understanding of, and make some assess-ment of, insurer corporate governance practices. As a result, whether through formal filings with state regulators, through

enhanced financial examination and analysis procedures, or both, insurers will likely be required to share more information about their governance practices in the not too distant future. Insurance examiners and financial analysts will have a responsibility to evaluate the adequacy of corporate gov-




Industry groups and other interested parties have expressed concerns

over how confidentiality will be maintained and that such an

additional regulatory filing might be duplicative and overly burdensome.



ernance and to determine how their assessments will influence the actions they take throughout the regulatory risk-focused surveillance cycle.

IAIS Insurance Core PrinciplesThe International Association of Insurance Supervisors (IAIS) has adopted a framework of 26 Insurance Core Principles (ICP) as guidance for global regula-tors in the conduct of their supervisory responsibilities over the insurance sector. For example, ICP No. 7 states that insurance regulators should require insurers “…to establish and implement a corporate governance framework which provides for sound and prudent management and oversight of the insurer’s business…” In addition, ICP No. 8 “…requires an insurer to have, as part of its overall corporate governance framework, effective systems of risk management and internal controls, including effective functions for risk man-agement, compliance, actuarial matters and internal audit.”

The ICP’s are significant for U.S. regulators, not only because they provide additional guidance on sound corporate governance practices, but also because in 2014 the U.S. will be evaluated by the International Monetary Fund in connection with its Financial Sector Assessment Program (FSAP) review of the U.S. financial regulatory system. In connection with this review, the effectiveness of the U.S. insurance regulatory system will be judged to a large degree against these ICP’s. Some of the key corporate governance principles included in ICP No. 7 include:

• Board involvement in setting and approving business objectives, strategies and risk appetite.

• Board oversight of senior management.• A Board composed of individuals with appropriate knowledge and exper-

tise and a sufficient level of independence and objectivity.• Board oversight of sound risk management and internal controls.• Board oversight of reliable financial reporting processes and effective inter-

nal controls over financial reporting.• A senior management structure that promotes sound risk management and

compliance practices, internal controls and performance monitoring.

Corporate Governance Assessment and the Risk-Focused ExamAn assessment of corporate governance and its role in a company’s enter-prise risk management (ERM) process is increasingly becoming one of the most critical aspects of a risk-focused financial examination. This is one aspect of the exam where examiners can leverage information from the insurer to gain an understanding of its key solvency risks, including prospec-tive risks and other than financial reporting risks. Experience has shown that companies with strong enterprise wide controls, including corporate gover-






nance and risk management, are more likely to have a strong overall system of internal controls at the functional activity, operating and financial report-ing process levels. The NAIC Corporate Governance Working Group initiatives described above will require examiners to become even more knowledge-able of corporate governance principles and best practices. These initiatives will also provide examiners access to more information about the corporate governance practices in place at individual insurers and; therefore, be in a better position to assess the adequacy of corporate governance during the course of a financial exam.

The Examiners Handbook already provides a significant amount of guidance on how the risk-focused examination process should include an assessment of the quality and reliability of the corporate governance structure and risk management programs. Exhibit M of the Examiners Handbook provides extensive guidance to assist examiners in conducting an assessment of the corporate governance structure and risk management functions including guidance on:

• Assessing the Board of Directors.• Evaluating the appropriateness of the organizational structure to manage

business activities and fulfill control responsibilities.• Understanding the delegation of authority throughout the organization.• Assessing management competence.• Reviewing the effectiveness of the risk management function.

The Corporate Governance Working Group is proposing that the Financial Examiners Handbook Technical Group consider developing additional guid-ance to Exhibit M, including further examiner review of the background of Directors, senior management and others in key internal control functions; further review of insurer remuneration policies; and assessment of Board oversight of contingency planning in large groups with significant affiliate relationships.

The guidance in the Examiners Handbook does not dictate what an insurer’s management oversight, corporate governance and internal control structure or documentation should include; however, the Handbook does indicate that “… examiners must consider and evaluate the insurer’s corporate gov-ernance and established risk management processes” and suggests that examiners should maximize the utilization of the corporate governance and risk management information made available by the company in complet-ing the examination. Based on his or her review and corroboration of the evidence provided, an examiner should reach a conclusion as to the overall effectiveness of the insurer’s corporate governance and risk management. A determination that corporate governance and risk management is effective can influence an examiner’s judgment when assessing the effectiveness of





risk mitigation strategies and controls at the functional activity level in Phase 3 of the exam as well as the residual risk assessment in Phase 4. For example, in a situation where an examiner is having difficulty making a judgment as to whether a specific identified control is a moderate or strong risk mitigation strategy and a directly related corporate governance practice is deemed to be effective, then the examiner might be justified in concluding the control under consideration is strong. On the other hand, if the corporate gover-nance practice is deemed to be ineffective, then a rating of moderate might be more appropriate. In either situation, the examiner’s thought process should be documented in the risk matrix.

It bears repeating that experience has shown that companies with strong enterprise wide controls, including corporate governance and risk manage-ment, are more likely to have a strong overall system of internal controls at the functional activity, operating and financial reporting process levels. This is one reason why so much attention is being directed towards these activi-ties in connection with the risk-focused surveillance process. Guidance in the area of corporate governance will continue to develop and evolve. As a result, it would be beneficial for examiners and analysts to begin now to enhance their professional skills within this discipline.

About the Author:Jim Stangroom, CPA, is a Managing Director with Invotex where he is responsible for assisting the firm’s insurance industry and regulatory clients in the areas of financial examinations, financial reporting, solvency and risk management. Invotex provides accounting, examination, financial analysis, risk management and other financial consulting services to help the insur-ance regulatory community achieve its goals with respect to the financial oversight of insurers and with respect to the supervision, rehabilitation and liquidation of financially troubled insurers.






Overview of HIPAA Omnibus Final Rule

By Denise Mainquist, CISA, CPHIT

After nearly two years of waiting, the Health Insurance Portability and Accountability Act (HIPAA) final rule was published on January 25, 2013. This new regulation is referred to as the HIPAA Omnibus because it incor-porates four final rules, including significant changes to HIPAA Privacy and Security Rules with enforcement and breach notification requirements under the Health Information Technology for Economic and Clinical Health Act (HITECH), as well as strengthening privacy protections for genetic information under the Genetic Information Nondiscrimination Act of 2008 (GINA). There is little wonder as to why it took several years to pull together this final rule.

Business AssociatesOne of the biggest changes in the HIPAA Omnibus is the expanded defini-tion of a Business Associate (BA). A BA is defined as “one who, on behalf of a covered entity, creates, receives, maintains or transmits Protected Health Information (PHI).” (A covered entity is the organization that is the primary creator or user of PHI, such as a hospital, physician’s office, health insur-ance company or government agency.) Subcontractors of BAs are also now included in the definition of a business associate. Previously, BAs were regulated indirectly through the use of BA agreements, but now business associates will be directly regulated by Health and Human Services (HHS). The new rule clarifies the definition of a BA as: “(1) A Health Information Organization, E-prescribing Gateway, or other person that provides data transmission services with respect to protected health information to a covered entity and that requires routine access to such protected health information; and (2) a person who offers a personal health record to one or more individuals on behalf of a covered entity.” There are many types of BAs used by a covered entity ranging from billing companies and claims clear-inghouses to website hosting and technology providers.

As PHI began to be shared or accessed more broadly by these third-parties, the number of breaches caused by third-parties increased significantly. Since the HITECH Interim Final Rule was implemented in September 2009, requiring covered entities to report breaches of 500 or more PHI records to the Secretary of Health and Human Services (HHS), it was found that 1-in-5 breaches is caused by a BA. Yet, the liability for the breach including costs of notifying patients, penalties and reputation damage fell to the covered entity. HIPAA also clearly spells out that BAs are now directly liable for compliance to the HIPAA Security and Privacy Rules and they can be directly investigated for compliance and breaches. This change is intended to lessen the burden on covered entities for assessing security controls at these third-parties.



Breach NotificationAnother major change to the HIPAA Omnibus package is the incorporation of the HITECH Breach Notification rule. First, the definition of a breach was expanded to include “unauthorized acquisition, access, use or disclosure of protected health information which compromises the security or privacy of such information.” The interim final rule contained a controversial provision referred to as the “harm standard,” which required covered entities, in the event of a breach of PHI, to perform a risk assessment to determine the like-lihood of financial, reputational or other harm to the individual whose PHI was breached. If there was a significant likelihood of harm to the individual, and over 500 records were breached, the covered entity was required to report the incident to the Secretary of HHS immediately. The final rule replaces the harm standard with a presumption that any use or disclosure of PHI not permitted by HIPAA is a breach unless the covered entity or business associate demonstrates that there is a low probability that the PHI has been compromised. This change has been mostly welcomed since it is a more logical approach to assessing a possible breach. The intent of the breach was to reduce the number of reported breaches, but there is some uncertainty as to whether this will be the case.

EnforcementIn the past, there was no situation where a compliance review of an orga-nization was mandatory. The final rule requires that the Secretary of HHS conduct a compliance review of the covered entity or business associate where initial review indicates a violation due to “willful neglect.” Willful neglect is defined as “conscious intentional failure or reckless indifference,” which basically means the organization didn’t take appropriate steps to prevent or correct the issue. A determination of willful neglect results in an automatic fine of $10,000-$50,000 per violation and total penalties may be as high as $1.5M. Each entity involved in a violation may be fined individu-ally, which of course now includes business associates. The Secretary of HHS has already assessed significant fines against covered entities and business associates, so it is likely this provision will continue to be exercised.

Additional ChangesAdditional changes in the rule include the following:

• Individuals will have better access to their own Personal Health Records (PHR) in electronic format.

• If a patient requests a restriction on disclosure of PHI, the covered entity must comply with the request. This may happen if an individual pays cash for medical services and does not want the claim to be filed with the insur-ance company.


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• Covered entities are restricted from making communications aimed at encouraging the use of a service or product, especially when the covered entity may profit from increased usage.

• Covered entities may no longer sell PHI without explicit authorization from the patient.

• Patients must be allowed to opt-out of the use of their PHI for fundraising activities by the covered entity.

• Notices of Privacy Practices (NPP) must be updated to advise individuals of these increased privacy protections. NPPs must be redistributed to all households.

• Individuals must specifically authorize the use of their PHI for research purposes.

What’s MissingA final rule on Accounting of Disclosures is one of the main components that is missing from the omnibus rule. This is the rule that requires all covered entities to be able to provide, at the patient’s request, a log of all disclosures of their PHI, including disclosures to third-parties. This is a nightmare for most organizations to track, especially when there may be multiple electronic systems used throughout an organization. There’s been a lot of push-back on this part of the interim rule so it’s not surprising this was not addressed in the current rule.

Effective DatesThe final rule is officially called “Modifications to the HIPAA Privacy, Security, Enforcement, and Breach Notification Rules Under the Health Information Technology for Economic and Clinical Health Act and the Genetic Information Nondiscrimination Act; Other Modifications to the HIPAA Rules; Final Rule” and becomes effective March 26, 2013. The compliance date is September 23, 2013, which gives covered entities and business associates 180 days to make needed adjustments to come into compliance. The Secretary of HHS has said that compliance penalties will not be assessed until after September 23, how-ever enforcement actions will continue in the meantime.

About the AuthorDenise Mainquist, CISA, CPHIT, is a Certified Information Systems Audi-tor (CISA), and a Certified Professional in Health Information Technology (CPHIT) with over 10 years of experience in Information Technology and related quality, standards and controls management, as well as experience defining and auditing IT controls, computer validation, software testing and managing implementations of policies, procedures and systems, document management/retention and ISO 9001 quality management systems. Denise was a Payment Card Industry Qualified Security Assessor (QSA) from 2007 to 2012. She is the founder of ITPAC Consulting and is a partner to NHA Services, a subsidiary of the Nebraska Hospital Association.


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Skills of an Effective Insurance Examiner

By Joanne Smith and John Humphries

Part 1: Who is an Effective Insurance Examiner?

The Composition of an Effective Insurance ExaminerIn order to be an effective insurance examiner, one must combine equal parts of regulatory knowledge, insurance industry knowledge, and a professional approach to the examination.

1) Regulatory Knowledge

A basic and fundamental requirement for an insurance examiner to be effec-tive and efficient when conducting statutory examinations of insurance companies is to have a solid knowledge of applicable state insurance laws and regulations. Without a strong understanding of the general requirements mandated by the state of domicile, the examiner could inefficiently spend too much time and resources reviewing areas that do not have statutory requirements. Or worse, examiners could entirely overlook areas with specific requirements in the state statutes, codes, laws and regulations. In order to be an effective examiner, one must have a deep understanding of state insur-ance laws. This deep understanding can be obtained through careful study of the insurance laws and through exam experience. Even though the NAIC releases Model Laws to provide suggested content for state legislatures, each state’s insurance laws and regulations are enacted with different verbiage which reflects the unique viewpoints of each state.

Other sources of regulatory knowledge can be found from the National Asso-ciation of Insurance Commissioners (NAIC) and the various handbooks and guidelines promulgated by the NAIC as reference materials. For example, the guidelines in the NAIC Market Regulation Handbook, NAIC Financial Condi-



tion Examiners Handbook, and the NAIC Market Analysis Handbook provide excellent information regarding best practices and suggested generic exami-nation procedures.

2) Industry Knowledge

Effective insurance examiners possess insurance industry knowledge about specific components and risk areas which make the insurance industry unique from any other business model. The fundamental concepts of insur-ance and the technical jargon used in insurance policies are highly special-ized for the insurance field. For example, it is essential that insurance examin-ers have a strong understanding of insurance products, how they work, and most importantly, how they affect consumers.

In addition, insurance examiners should understand modern policy adminis-trative and claims systems. A working knowledge of past systems is also use-ful for many issues that may have originated decades ago. Examiners should understand the flow of information from policy issue to claim is reported, and how the policy and claim systems interact with the accounting function. This understanding of the IT functions is crucial to effectively tracing the premium and loss amounts from source data to the Annual Statement.

3) Professional Approach

Effective insurance examiners always approach each examination with a professional attitude. By treating the Company management and employees with respect, and by staying professional in emails, phone conversations, and face-to-face meetings, examiners are able to more effectively and efficiently proceed through examination procedures. The Company management is more likely to be cooperative and respond quickly to information requests that are made with a professional and non-accusatory tone. Effective examin-ers are “politely persistent” when following up on requests, and are firm when necessary, but always professional.

Another key component of taking a professional approach to an examination is to do your homework and learn key facts about the Company. Effective examiners take the time to know a little bit about the Company’s products, markets, and key issues from the very beginning of the examination. Exam-iners can coordinate with the Department Analyst to determine key areas of concern and high risk. In addition, a review Market Analysis Report at the beginning of the exam can provide valuable insight and knowledge about the Company. Taking the time to perform some basic research prevents the Company management from having to explain basic details of the Company to the examiner and helps maintain the examiner’s credibility as an educated professional.


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How to Become a Highly Effective Insurance ExaminerIn the bestselling book, “The 7 Habits of Highly Effective People” by Stephen R. Covey, seven ways to become a highly effective person are described. These same principles can be applied to almost any life situation, including becoming a highly effective insurance examiner.

1) Be Proactive

Highly effective insurance examiners recognize that each individual exam team member is responsible for the success of the exam. All should take action to make sure that all aspects of the examination are completed in a timely manner.

2) Begin with the End in Mind

Highly effective insurance examiners create clear exam objectives and com-municate these objectives to all exam team members at the beginning of the exam. Furthermore, highly effective examiners do not allow themselves to be distracted with immaterial side issues.

3) Put First Things First

Highly effective insurance examiners carefully plan, prioritize, and execute examination procedures based upon importance and not urgency.

4) Think Win-Win

Highly effective insurance examiners work to get the right answer even if it is not “your” answer. In addition, highly effective examiners work on behalf of all parties to find win-win solutions when possible.

5) Seek First to Understand, Then to be Understood

Highly effective insurance examiners work to understand all sides of an issue before reaching conclusion.

6) Synergize

Highly effective insurance examiners focus on the strengths of each exam team member and allocate tasks according to each individual’s strengths and areas of expertise.

7) Sharpen the Saw

Highly effective insurance examiners keep learning and keep growing in insurance and auditing knowledge since they recognize that the world of examinations will continue to change over time. For example, in a dynamic



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internet age of social media, new insurance products, a changing economy, and many other socio-political factors, examiners need to stay abreast of changes to effectively and efficiently conduct examinations.

Part 2: Effective Examiners Secure Data

Data SecurityInsurance examiners receive large amounts of extremely valuable data. In order to be an effective examiner, an examiner must maintain control of the security of this data that they have been entrusted with at all times. Data from insurance companies can be extremely sensitive in nature. For example, examiners are often entrusted with information about insureds or claimants which contains private information about personal health, finances, etc. that must be kept private. Examiners also have access to confidential information about the Examined Company’s corporate strategy or competiveness that cannot be released to its competitors.

How do you protect this data?

The first step in protecting data is to be aware of the physical location of the data at all times. Data can be stored on personal computers, laptops, office network servers, memory sticks, email servers, smart phones, or on a CD being shipped across the country.



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Physical Security

The most basic method to secure data is to simply not leave the data unat-tended at any time, but this is not always practical or possible. When traveling on business trips, a best practice is to put laptops in the hotel room safe or use a cable lock to secure the laptop to a heavy piece of furniture to discour-age theft. Another method is to place a “do not disturb” sign on the hotel room door to minimize entry by hotel staff. Additionally, keeping the laptop and/or memory stick containing the data out of sight l provides another level of protection. And above all, use common sense when traveling with sensi-tive data and take necessary steps to protect your data.

Logical Security

After ensuring the physical security of the data, the next step is to protect the data from logical threats of hacking, manipulation, and theft. The most funda-mental method of providing logical protection, is through the use of pass-words to access the laptop, network, database, spreadsheet, or document. Use “strong” passwords to properly secure the data. According to the article, “What Every IT Auditor Should Know About Access Controls” published in the ISACA Journal, Vol. 4, 2008, strong passwords are composed of 8 characters or more, and are a mixture of uppercase, lowercase, numbers, and special char-acters. In addition, these strong passwords should be required to be changed every 90 days or other regular interval. Strong passwords should also be used for team members in TeamMate, or any other audit software used to conduct the examination.

In addition to strong passwords, sensitive data can be protected using encryption. There are many varieties of encryption software, and h examin-ers must carefully consider which type would be best suited to their needs. Microsoft Office provides standard encryption of single files. Compression programs, such as WinZip, can provide encryption for groups of files while also reducing the size of the space needed to transport the data. Encryption software, such as TrueCrypt, has the ability to encrypt an entire volume of a memory stick or computer hard drive.

Finally, examiners must backup data to preserve the work that they have performed.

Bottom Line

Effective examiners recognize that examination data must be protected and that they should consider where the data is “stored” at all times. The world of technology is ever changing and creating new advancements and also new threats. Examiners are responsible for the data they receive and must find


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a way to navigate the changes. Effective examiners take steps to secure the data that they have been entrusted with and always use common sense.

Part 3: Effective Examiners Utilize CAAT

Computer Aided Audit Techniques (CAAT)Effective insurance examiners recognize that computer aided audit tech-niques (CAAT) are an effective regulatory tool that provide concrete evidence for examinations issues and findings, especially during market conduct examinations. CAAT analysis and monitoring by regulators can provide: tan-gible and concrete results, statistics to effectively determine true compliance rather than just anecdotal evidence, and assist examiners to find “needles in the haystack” within large volumes of data.

Sources of Data

In order to successfully implement CAAT analysis, effective examiners must first consider the source of the data that they want to analyze. Is the data pro-duced routinely by the Company? Does the analysis require a highly tailored file layout? Standard Data Request specifications provide a good starting point noting that any data request should be tailored to meet examination objectives and avoid unnecessary work on the part of the exam team and the examined company.

Large Data Files

Effective examiners should expect and prepare for very large data files from the examined company. The first step is to know how to transfer the data from the company to the examiner. Oftentimes email servers have size limitations and lower levels of data security that make email transmittal an unattractive and not a feasible method to transfer the large data file. Sav-ing the large data file to a CD, DVD, memory stick, or external hard drive and shipping it via FedEx or USPS is another option for data file transfer; however, examiners must take into consideration the size limitations of these media and data security. Always encrypt sensitive data before shipping to protect the data during transit. A more direct approach that should be considered is direct file upload via secure internet connection using a file upload site such as SharePoint. Direct file upload provides advantages such as a fast turn-around and avoidance of loss during shipping. However, examiners should be aware that direct file transfer requires close attention and management of access rights.


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Examples of CAAT Applications

Two practical examples of the application of computer aided audit tech-niques can be found in prompt pay analysis of health insurance claims and in market conduct examinations of insurance companies to determine if race was ever used as an underwriting factor for life insurance policies even if the business was sold decades ago. Of course, the opportunities to implement CAAT analysis to examine insurance companies are endless. Effective examin-ers contemplate new situations which would benefit from CAAT analysis to enhance the effectiveness of their examination results.

Source: Article adapted from the “Skills of an Effective Insurance Examiner: How to become a highly effective examiner” webinar presentation for members of the Insurance Regulatory Examiners Society (IRES) on December 7, 2011, presented by John Humphries.

About the AuthorsJohn Humphries, ASA, MAAA, CFE, CISA, AES, MCM, is the Managing Part-ner of AGI Services, where he has worked exclusively with State Insurance Departments for the past twenty years as a consultant on examinations of Managed Care Organizations, Life and Accident companies, Property & Casu-alty companies, as well as numerous other regulatory projects covering both financial and market conduct issues. Because John’s work is focused on the needs of regulators, he understands the regulatory process and works hard to identify both problems and solutions. John can be contacted at [email protected] or 770-774-1102.

Joanne Smith is an Examiner at AGI Services, where she works exclusively with State Insurance Departments on financial examinations of Risk Reten-tion Groups, Property & Casualty, Life, and Health insurance companies. Joanne also serves on the Publications Committee of the Society of Financial Examiners (SOFE). Joanne can be contacted at [email protected] or 770-774-1101 ext. 219.






Insurance and Behavioral

Economics:

Improving Decisions in the Most

Misunderstood Industry

By: Howard Kunreuther and Mark Pauly,

Wharton Risk Management and Decision Process Center

Behavioral biases can cause consumers, insurers and regulators/politicians to make poor insurance decisions for low-probability, high-consequence events.

• People have a tendency to estimate the likelihood and consequences of future disasters by focusing on recent past experience.

• Residents in hazard-prone areas fail to take protective measures prior to a disaster if its perceived likelihood is below their threshold level of concern.

• People focus on short time horizons when comparing the expected benefits of reduced losses from investing in protection with their upfront costs.

• These behaviors are common for low-probability, high-consequence events, but not for insurance purchased against other kinds of losses.

Consumers: Focus on recent past experience.

Example: Many homeowners do not buy flood insurance because they misperceive the risk of damage as being extremely low. They are likely to buy insurance after a flood, and then several years later, cancel their policy.

Insurers: Correlated losses pose challenges.

Example: Prior to 9/11, insurers viewed losses from terrorism as so improb-able that the risk was not explicitly mentioned or priced in any standard policy despite the attempted bombing of the World Trade Center in 1993. After 9/11, most insurers refused to offer terrorism insurance at all rather than calculating a premium reflecting their best estimate of the risk.

Regulators: Concerned with re-election as well as fairness and equity

Example: Insurance regulators aided Florida homeowners in hurricane-prone areas by setting up a state insurer – the Citizens Property Insurance Corpora-tion – that offered coverage at prices lower than insurers would have charged at premiums reflecting risk.

We propose these guiding principles for insurance to overcome behav-ioral biases and to make insurance more transparent and equitable, and to encourage investment in protective measures.

Principle 1: Premiums reflecting risk. Insurance premiums should be based on risk to provide proper signals to individuals for buying insurance, and to encourage them to invest in cost-effective mitigation measures to reduce their vulnerability to catastrophes.

Principle 2: Dealing with equity and affordability issues. Any special treat-ment given to homeowners currently residing in hazard-prone areas (e.g., low-income or inadequately insured homeowners) should come from general public funding and not through insurance premium cross-subsidies.

Editor’s Note: This article expounds upon the Flood Insurance Reform

Act of 2012 and the Affordable Care Act, and provides suggestions for

improvement in the flood insurance and healthcare industries from an behavioral economic perspective.


Insurance and Behavioral Economics:



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Principle 3: Multi-year insurance. To encourage investment in protective measures, insurers should design multi-year contracts with premiums reflect-ing risk. The price of this insurance may be higher than single year coverage, but would provide consumers with price stability. Regulators would have to allow insurers to charge premiums that reflect risk, and allow them to modify contracts if regulatory rules change during the contract period.

Strategies to alleviate consumers’ behavioral biases with respect to low-prob-ability, high-consequence events:

• Provide better information on the role of insurance: Highlight that the best return on an insurance policy is no return at all.

• Focus on consequences of being uninsured: Describe the financial problems one would face if her home were destroyed by a disaster or if she were hos-pitalized due to a serious illness.

• Stretch the time horizon to make the event for salient: If an event such as a flood has a 1 in 100 chance of occurring next year, present the probability as a greater than 1 in 5 chance of happening in the next 25 years.

• Offer multi-year flood insurance policies. Because regulations in many states prevent insurers from setting premiums that reflect risk, multi-year insurance should be initiated under the federally-run National Flood Insur-ance Program with coverage tied to the property rather than to the current homeowner. When the property is sold, the multi-year insurance contract would be transferred to the new owner.

Strategies to alleviate insurers’ behavioral biases with respect to low-proba-bility, high-consequence events:

• Construct worst-case scenarios that characterize potential disaster losses so that insurers focus on the consequences of these extreme events in their pricing and coverage decisions.

• Assign likelihoods to these worst-case scenarios and specify uncertainties surrounding these and other scenarios to determine under what conditions a particular risk is insurable.

• Consider providing flood coverage in certain markets using more accurate flood maps to determine areas where the private insurance market can provide flood coverage at competitive rates.

Strategies to alleviate regulators’ and politicians’ concerns with equity and re-election:

• Design equitable ways to assist low-income consumers in purchasing insurance using a means-tested insurance voucher provided by the federal government or at a state level.

• Appoint civil servants as regulators so they don’t focus their attention on short-term policies that increase their chance of being re-elected.



• Require regulators to hold hearings and provide full disclosure before ren-dering decisions. Regulations should make transparent who is expected to benefit and who is likely to pay a greater share as a result of these actions.

Evaluation of the New Flood Insurance and Health Care Legislation within the Framework of the Guiding Principles for InsuranceWith the signing into law of the Biggert-Waters Flood Insurance Reform Act in July 2012 that renews the National Flood Insurance Program (NFIP) for five years, there is an opportunity to encourage those residing in flood-prone areas to take steps to reduce their losses in advance of the next disaster by modifying the program to reflect the above guiding principles for insurance. The Affordable Care Act (ACA) legislation taking effect in 2014 in some ways follows the guiding principles and in some ways does not.

Source: This article appeared in the Winter 2013 Issue Brief published by Wharton Risk Management and Decision Process Center of the University of Pennsylvania. Reprinted with permission.




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Table: How well does the new legislation align with the guiding principles for insurance?

Flood Insurance Reform Act of 2012

Affordable Care Act (ACA) (“Obamacare”)

Principle 1:Premiums reflecting risk

YES: The Reform Act phases in risk-based pricing over a period of five years and removes rate subsidies for vacation homes.

NO: The ACA forbids insurance premiums to be based on risk (given age). Low risks cross-subsidize the higher risks by being charged prices that exceed their risk- based premiums. The law does permit premiums to be adjusted to reflect smoking behavior and participation in workplace wellness programs.

Principle 2:Dealing with equity and affordability issues

PARTIALLY: The Reform Act authorizes the Federal Emergency Management Agency and the National Academy of Sciences to examine the use of a means-tested insurance voucher system for homeowners who cannot afford to pay risk-based rates without financial assistance. The legislation does not address the immediate affordability issues for those who will see premium increases this year and next.

YES: The ACA is designed to satisfy equity and affordability considerations, the most important failing of current health insurance markets.

Principle 3:Multi-year insurance

NO: Multi-year insurance should be feasible, since the federal government is the provider of almost all flood insurance policies for homeowners.When the property is sold, then the multi-year flood insurance contract should be transferred to the new owner.

YES: Almost all private individual medical insurance carries a provision guaranteeing renewal in the following year at premiums that are not altered based on any exogenous change in the person’s risk. In other words, there is multi-year protection against reclassification of a person’s risk. This provision is required for all individual insurance under the ACA.




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About the Wharton Risk CenterEstablished in 1984, the Wharton Risk Management and Decision Processes Center develops and promotes effective corporate and public policies for dealing with catastrophic events including natural disasters, technologi-cal hazards, terrorism, pandemics and other crises. The Risk Center research team—over 50 faculty, fellows and doctoral students—investigate how indi-viduals and organizations make choices under conditions of risk and uncer-tainty under various regulatory and market conditions, and the effectiveness of strategies such as alternative risk financing, incentive systems, insurance, regulation, and public-private collaborations at a national and international scale. The Center actively engages multiple viewpoints, including top repre-sentatives from industry, government, international organizations, interest groups and academia. More information is available at http://www.wharton.upenn.edu/riskcenter.

About the AuthorsHoward Kunreuther is a Professor of Decision Sciences and Business and Public Policy at the Wharton School, and co-director of the Wharton Risk Management and Decision Processes Center. He has a long-standing interest in ways that society can better manage low-probability, high-consequence events related to technological and natural hazards. He is a member of the National Research Council’s panel on Increasing National Resilience to Hazards and Disasters and serves the Intergovernmental Panel on Climate Change (IPCC) as a chapter lead author of the IPCC’s 5th Assessment Report on Integrated Risk and Uncertainty Assessment of Climate Change Response. He is a Fellow of the American Association for the Advancement of Science, and a Distinguished Fellow of the Society for Risk Analysis, receiving the Society’s Distinguished Achievement Award in 2001. He can be contacted at [email protected].

Mark V. Pauly is a Professor in the Department of Health Care Systems at the Wharton School of the University of Pennsylvania. Dr. Pauly is a former commissioner on the Physician Payment Review Commission and an active member of the Institute of Medicine. One of the nation’s leading health economists, Dr. Pauly has made significant contributions to the fields of medical economics and health insurance. His work in health policy deals with the appropriate design for Medicare in a budget-constrained environment and the ways to reduce the number of uninsured through tax credits for pub-lic and private insurance. He is an appointed member of the U.S. Department of Health and Human Services National Advisory Committee to the Agency for Healthcare Research and Quality, and co-editor-in-chief of the Interna-tional Journal of Health Care, Finance, and Economics. He can be contacted at [email protected]




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http://www.wharton.upenn.edu/riskcenter

http://www.wharton.upenn.edu/riskcenter




NAIC 2012 Fall National Meeting

.

NAIC Meeting NotesGlobal Insurance Industry Group, Americas

The National Association of Insurance Commissionerheld its Fall National Meeting in National Harbor,MD November 27-December 2. This newslettercontains information on activities that occurred insome of the committees, task forces and workinggroups that met there. This Newsletter also coversconference calls held throughout December. Forquestions or comments concerning any of the itemsreported, please feel free to contact us at the addressgiven on the last page.

www.pwc.com/us/en/insurance


PwC Insurance Industry NAIC Meeting Notes | January 6, 2013

www.pwc.com/us/en/insurance 1

Executive Summary

After nearly eight years of often intense effort,the Commissioners adopted the ValuationManual for Principles-Based Reserving, whichwill allow the Standard Valuation Lawamendments and related state legislationnecessary for PBR along with the ValuationManual to be presented as a package in 2013.(page 2)

The Statutory Accounting Principles WorkingGroup continued discussion of significantprojects including accounting for the AffordableCare Act fee to be paid in 2014, a proposed newdisclosure for seed money in separate accountsand potential new disclosures for restricted/pledged assets. (page 3)

The Emerging Accounting Issues WorkingGroup exposed for comment on January 3 aproposed one-time extension of the 90 day rulefor amounts due from agents and policyholdersdirectly impacted by Hurricane/SuperstormSandy. (page 6)

The Capital Adequacy Task Force agreed tomaintain the present level of public disclosureof RBC results in the annual statement, butdeferred action on a proposal to increase theRBC charge on restricted/pledged assets. TheC-1 Factor Review Subgroup continues toconsider a recalibration of RBC C-1 factors andexpects to complete its work during 2013 withthe potential implementation of revised C-1factors in the 2014 RBC calculation. The SMIRBC Subgroup continued its discussions ofoperational risk. (page 6)

The Life RBC Working group discussed theACLI commercial mortgage proposalthroughout the fall, and in National Harborvoted unanimously in favor of continuing towork toward adopting a proposal that would beeffective for 2013. The Catastrophe RiskSubgroup discussed comments pertaining to theRBC formula spreadsheets to incorporateproperty/casualty catastrophe risk for 2013,and adopted a requirement for companies tosubmit catastrophe loss data on aninformational-only basis for 2012. The HealthRBC continues to monitor the impact of ACA.(page 8)

The IAIS 2012 Annual Conference was held inWashington DC in October; its discussions

focused on ComFrame, a critical project toupdate supervisory practices. The IAIS releasedfor comment its proposed policy measures thatwould be applied to Global SystemicallyImportant Insurers. (page 12)

Following adoption of the Valuation Manual bythe Plenary and Executive Committee, the PBRWorking Group was elevated to an executive-ledjoint working group of the Life Insurance andAnnuities and Financial Condition Committees,which will work on PBR implementationguidelines. The working group discussed itsdraft implementation plan for PBR and exposedthe plan for public comment until January 10,2013. (page 13)

This fall the NAIC adopted the Group SolvencyIssues Working Group’s Risk Management andOwn Risk and Solvency Assessment Model Act(#505) which is expected to be effective January1, 2015 when adopted by the states. Theworking group plans to develop a new sectionfor the Financial Analysis Handbook that willdocument the U.S. state regulatory approach togroup supervision, and the role of the lead stateregulator. (page 15)

The ORSA Subgroup recommended changes tothe ORSA Guidance Manual to reflect theresults of the ORSA pilot project and adoptionof the Risk Management and ORSA Model Act,and exposed the amended draft for a 60-daycomment period. The subgroup recommendedreferrals to the Financial Analysis HandbookWorking Group and the Financial ConditionExaminers Handbook Technical Group fordrafting of guidance for the review of insurers’ERM processes and the ORSA. (page 16)

The Corporate Governance Working Groupexposed for comment updated drafts of itscontroversial proposed Exhibits A, B, and Efrom its document "Proposed Response to aComparative Analysis of Existing U.S.Corporate Governance Requirements" untilJanuary 18 2013. (page 16)

The International Accounting StandardsWorking Group heard updates on the insurancecontracts and financial instruments projects ofthe FASB and IASB. (page 18)

The International Insurance RelationsCommittee heard updates on the IAIS’s




Financial Stability Committee, EU-U.S.Dialogue Project, Joint Forum, and ComFrame.(page 18)

The Valuation of Securities Task Force adoptedthe controversial assumptions for 2012financial modeling of RMBS and CMBSinvestments in October; the new assumptionsmark a shift toward a more conservative bias.The task force also adopted the proposedstatutory accounting framework for WorkingCapital Finance Investments. (page 21)

The Reinsurance Task Force exposed forcomment the draft "NAIC Process forDeveloping and Maintaining the List ofQualified Jurisdictions," a document thatincludes an evaluation methodology coveringthe industry, regulatory framework andmeasures applicable to U.S. reinsurersoperating overseas, until January 16, 2013. Thetask force heard an update on the adoption ofthe revised credit for reinsurance models by thestates. The task force was informed that NewYork and Florida have each approved more thana dozen entities as Certified Reinsurers.(page 23)

The Captives and Special Purpose VehiclesSubgroup continued work on its controversialwhite paper on the use and regulation ofcaptives and SPVs, which may recommendsignificant changes to the current regime. Thesubgroup received and discussed comments onthe draft white paper in National Harbor, and anew draft of the white paper is expected shortly.(page 24)

The Blanks Working Group exposed 10 newblanks proposals for public comment at the FallNational Meeting. (page 25)

The Life Actuarial Task Force continued itsdiscussion of proposed revisions to VM-20,PBR for Life Products. The task force alsodiscussed options to address the perceivedreserve redundancies created by AG 33, but noconclusions were reached. (page 26)

The Emerging Actuarial Issues Working Group,formed this fall, reviewed and approvedinterpretations from questions received on therecently adopted revisions to AG 38 foruniversal life products with secondaryguarantees. (page 28)

The Health Insurance and Managed CareCommittee heard an update from the Center forConsumer Information and InsuranceOversight on the Affordable Care Actimplementation activities. (page 28)

The Contingent Deferred Annuity WorkingGroup heard comments on its draft proposedrecommendations regarding the regulation ofcontingent deferred annuities. (page 29)

The Financial Regulation Standards andAccreditation Committee voted to include theCredit for Reinsurance Model Law and ModelRegulation as accreditation requirementseffective immediately for states which areconsidering collateral reductions. (page 29)

Executive Committee andPlenary

Note: All documents referenced in this Newslettercan be found on the NAIC's website at naic.org.

Election of OfficersThe NAIC held its annual election of officers and theofficers for 2013 are as follows: Commissioner JamesDonelon of Louisiana was elected President, NorthDakota Commissioner Adam Hamm was chosen asPresident-Elect, Commissioner Monica Lindeen ofMontana was elected as Vice-President andPennsylvania Insurance Commissioner Michael F.Consedine was chosen as Secretary-Treasurer.

Adoption of New or Revised ModelsThe Executive Committee and Plenary held a jointconference call in September at which both

committees adopted the Risk Management and OwnRisk and Solvency Assessment Model Act (#505),and the amendments to Actuarial GuidelineXXXVIII—The Application of the Valuation of LifeInsurance Policies Model Regulation (AG 38).

The Executive Committee and Plenary also adoptedthe following items:

The Valuation Manual for Principles-BasedReserving (PBR). The Valuation Manual wassubject to extensive discussion, and passednarrowly. Details of the discussions and thecurrent status of PBR are summarized below aspart of the PBR Working Group summary.




The NAIC Model Rule (Regulation) forRecognizing a New Annuity Mortality Table forUse in Determining Reserve Liabilities forAnnuities (#821)

Amendments to the Business Transacted withProducer Controlled Insurer Act (#325), toremove the exclusion for Risk Retention Groups

Best Practices for Rate and PremiumComparison Tool

Best Practices and Guidelines for ConsumerInformation Disclosures

The Executive Committee and Plenary adopted theRisk-Based Capital for Health Organizations ModelAct (#315) and the 2011 Revisions to the Model RiskRetention Act (#705) into the AccreditationStandards, and agreed to expose the 2011 Revisionsto the Risk-Based Capital for Insurers Model Act(#312) for an additional one-year comment periodfor accreditation purposes.

Executive CommitteeSince the Summer National Meeting, the ExecutiveCommittee has held five interim conference calls. OnSeptember 19, the Executive Committee approved anew charge for the Mortgage Insurance WorkingGroup to determine and make a recommendation tothe Financial Condition Committee on changesnecessary to the solvency regulation of mortgageinsurers, including changes to the MortgageGuaranty Insurers Model Act (#630). On October 19,the Executive Committee adopted a charge for theFinancial Condition Committee to form theEmerging Actuarial Issues Working Group todevelop guidance with respect to requirementsunder AG 38; see details of the working groupdiscussion on page 28.

At the Fall National Meeting, the ExecutiveCommittee adopted model law development foramendments to Long-Term Care Insurance ModelAct (#640), Long-Term Care Insurance ModelRegulation (#641), and Property and CasualtyActuarial Opinion Model Law (#745).

Appointment of NAIC InterimCEO

On November 14, the Executive Committee approvedthe appointment of Andrew J. Beal as interim CEO,following an announcement regarding theaccelerated departure of former CEO Dr. TheresaVaughan on November 30.

Statutory Accounting PrinciplesWorking Group

The working group met in National Harbor anddiscussed the following issues. (After each topic is areference to the SAP Working Group’s agenda itemnumber.) The working group also held a conferencecall December 18th to discuss accounting for thePPACA fee (detailed below), during which the long-time chair Joe Fritsch announced that he would beretiring at the end of the year from the New YorkInsurance Department. The new chair of the SAPWorking Group has not yet been announced.

Adoption of New Standards or Revisionsto SSAPs

Disclosure of Permitted Practices (2012-04) – Theworking group adopted a proposal to amend SSAP 1to require disclosure in each applicable financialstatement note if the amounts reported in that notehave been adjusted by state prescribed or permittedpractices. This would be in addition to the certaindisclosures related to practices that differ from NAICprescribed.

Clarification of Measurement Date (2012-19) – Theworking group adopted a proposed change in theeffective date of the measurement date change toDecember 31, 2014 in SSAP 92 and SSAP 102 andadopted a clarification that INT 03-18, Accountingfor the Change in Additional Minimum Liability, isnullified by SSAP 102.

Additional Pension and OPEB Guidance (2012-18) –The working group adopted three additionalimplementation examples for underfunded pensionplans with a prepaid benefit cost (no deferral elected,deferral elected with a funded ABO and deferralelected with an unfunded ABO) which includesuggested revisions from interested parties. Theworking group also adopted revisions to the firstthree examples, which had been previously adopted.

SSAP 61 and SSAP 62 Amendments to Incorporatethe Concept of Certified Reinsurer (2011-10 & 11) –In June the working group adopted revisions to thereinsurance SSAPs to provide specific accountingguidance for reinsurance ceded to certifiedreinsurers, a concept that was adopted by the NAICas part of the Reinsurance ModernizationFramework. At the Fall National Meeting, theworking group adopted proposed guidance anddisclosures to both SSAP 61 and 62 related tocertified reinsurers which have been downgraded;this guidance is effective December 31, 2012. The




working group also adopted additional revisions toSSAP 62R to make certified reinsurance guidanceconsistent with the language adopted in SSAP 61 asmodified at the Fall National Meeting. During itsDecember 18 conference call, the working group alsoadopted consistency changes to SSAP 61 and SSAP62, as well as placement of Emerging ActuarialInterpretations in the Accounting Practices andProcedures Manual.

ASU 2010-20 Receivables-Disclosures About theCredit Quality of Financing Receivables and theAllowance of Credit Losses (2011-22) – The workinggroup adopted proposed revisions to SSAP 34 andSSAP 37 to incorporate GAAP “financing receivable”disclosures specific to mortgage loans effective foryear-end 2013 financial statements. Note that thesedisclosures have been considered for the auditedfinancial statements since 2011 because of thestatutory OCBOA disclosure requirements.

Issue Paper 132, Accounting for Pensions and IssuePaper 133, Accounting for Postretirement BenefitsOther than Pensions – At the Fall National Meeting,the working group exposed for comment updatedissue papers reflecting the adopted guidance inSSAPs 92 and 102. These issue papers were adoptedas final during the working group’s December 18th

conference call.

ASU 2011-22, Disclosures about Offsetting Assetsand Liabilities (2012-17) – The working groupadopted the following effective January 1, 2013:1) revisions to ensure offsetting only in accordancewith SSAP 64; 2) modify the adoption of FIN 39rejecting the ability to offset in accordance withmaster netting agreements and rejecting FSP FIN39-1 and FIN 41; and 3) reject ASU 2011-11 forstatutory accounting. The ASU was rejected as itpermits optionality for offsetting repurchase andreverse repurchase agreements under master nettingarrangements. The working group deferred theadoption of the disclosures required by ASU 2011-11until the FASB completes its project to narrow thescope of the offsetting disclosures.

Exposure of New Guidance andDiscussion of New and On-goingProjects

Comments on exposed items are due to NAIC staffby February 8.

Policyholder Loyalty Program Obligations (2012-15)and Actuarial Calculation of DDR Reserve (2012-16)At the Summer National Meeting, the working groupexposed for comment proposed amendments toSSAP 65, P&C Contracts, to address loyalty programbenefits and additional guidance on reporting thedeath, disability and retirement (DDR) reserve.Based on the significant number of comment lettersreceived from interested parties and the CasualtyActuarial and Statistical Task Force, the workinggroup asked staff to collect additional informationand report back to the working group.

Seed Money Disclosures (2012-23) – The workinggroup exposed for comment a proposed newdisclosure related to seed money and fees andexpenses due to the general account, the intent ofwhich is to identify the materiality of seed money inthe separate account. The proposal also includes asample disclosure/illustration.

Hedge Accounting Requirement (2012-24) –Theworking group exposed for comment a proposedclarification to SSAP 86 that hedging transactionswhich meet the hedging effectiveness criteria canfollow fair value hedge accounting if elected by thereporting entity i.e. it is not mandatory to followhedge accounting when a transaction qualifies forsuch accounting.

Preferred Stock Class of ETFs (2012-30) – Thisproposal is to add a preferred stock class ofExchange Traded Funds to the APP Manual,provided the SVO criteria are met. Under currentstatutory accounting, ETFs are classified either ascommon stock, or as bonds when specific criteria aremet.

Inconsistency Regarding Tax Planning Strategies(2012-31) – NAIC staff has identified aninconsistency between SSAP 101, paragraph 14 andthe Q&A paragraph 13.6 as to when consideration oftax planning strategies is required. The workinggroup exposed proposed clarifications to the SSAP toclarify that tax planning strategies are not requiredin the admittance calculation but if used should beconsistent with the tax planning strategies used incomputing the statutory valuation allowance if suchstrategies were used in the SVA determination.

Impact of Loss Portfolio Transfer on Provision ofReinsurance (2011-45) – The working group willhold an interim conference call to discuss thisproposal from a large P&C insurer, which addressessituations where collection risk for third partyreinsurance has been transferred and secured by thecounterparty in a LPT, but novation has notoccurred. The call was expect to occur in December,




but has not yet been scheduled. A new LPT issue isalso expected to be discussed on that call; a proposalfrom a large property/casualty company regardingLPTs between affiliates where there is no gain insurplus was briefly discussed in National Harbor.The company would like reconsideration of theaccounting for the LPT, i.e. for the payment to theassuming company to be accounted for as a paid lossand not ceded premium.

Title Insurance Loss Reserves (2012-33) – Theworking group exposed for comment proposedrevisions to SSAP 57, Title Insurance, to clarify thereporting of loss reserves including known claimsreserves, statutory premium reserves, supplementalreserves and the bulk reserve.

SSAP 100 and Review of ASU 2011-04 (2012-14)There was no discussion on the progress of the IssuePaper to address ASU 2011-04, but staff hopes tohave an exposure draft by the 2013 Spring NationalMeeting.

SSAP 43R Subgroup – The subgroup met twice thisfall via conference call to consider possible revisionsto the definition of loan-backed and structuredsecurities in SSAP 43R as requested by interestedparties. Per their comment letter, interested partiesbelieve SSAP 43R is being inconsistently applied,and would like the standard to be “more principles-based and objective.” The two conference calls weresimilar to many other discussions of this topic, withsome regulators wanting to keep the definition morebroad and interested parties arguing for a narrowerinterpretation. One recommendation suggested wasthat if ultimate repayment is from a singleobligor/debtor, then the insurance company holdershould consider the structural features to see if it thesecurity is overly dependent on overallcollateralization or subordination. If the answer tothose questions is yes, then interested parties agreeit belongs in SSAP 43R. The subgroup distributed anExamples of Securities under Discussion memowhich documents New York’s view why variouscomplex instruments are appropriately classified asSSAP 43R securities. No conclusions have beenreached; the next call of the subgroup has beententatively scheduled for sometime in January.

Restricted Asset Issues – The working groupdiscussed a referral from the Financial AnalysisWorking Group requesting research of certainguarantees and other financial activities that havepledge-like restrictions. The working group askedNAIC staff to begin work on addressing the issuesincluding consideration of enhanced disclosures.The working group briefly discussed Interrogatory24 of the annual statement which summarizes assets

“not exclusively under the control of the reportingentity,” and questioned whether this interrogatorycaptures all such restricted assets. Note that theCapital Adequacy Task Force had significantdiscussion of a proposed higher RBC charge forrestricted assets; see that discussion on page 7.

Derivatives Investment Reporting – The SAPWorking Group formed a Derivatives InvestmentReporting Subgroup to review gain recognition forchanges in variation margin for futures contracts.The NAIC is aware that insurers are treating itinconsistently, with some companies reporting thechange as realized gain/loss while others arereporting it as unrealized gain/loss.

Working Capital Finance Investments – The workinggroup received a referral from the Valuation ofSecurities Task Force which recommends thatworking capital finance investments be included as anew invested asset class (after much discussion in2011 and 2012 by the task force). Interested partieshad hoped the guidance would be effective in early2013 so that insurers can invest in theseinstruments. The working group will hold interimconference calls to expedite consideration. See page22 for additional discussion of WCFI.

SSAP 35R - ASU 2011-06, Fees Paid to the FederalGovernment by Health Insurers (2011-38) - Theworking group held an interim call on December 18th

to continue discussion of the accounting for the newhealth insurer fee mandated by the federal PatientProtection and Affordable Care Act. In June 2012,the SAP Working Group had concluded that they willnot require accrual of the fee in 2013, but thatcompanies should disclose the dollar effect of theassessment at year-end 2013, in accordance withSSAP 9, Subsequent Events.

The purpose of the conference call was to discuss allthe various views and not to make any decisions. Thecall was unexpectedly contentious with very spiriteddebate. The chair of the Financial ConditionCommittee, Commissioner Torti, was especiallyvocal in his comments, stating that the GAAPguidance for the fee (i.e. record in 2014) is"ridiculous and outrageous," which has interestedparties understandably concerned.

The working group heard first comments frominterested parties where they expressed their beliefthat the fee, which is payable each September, is acost of doing business in that year and should berecognized as an expense over the course of thatyear. The fee will be levied each year only on thosecompanies that are engaged in the business ofproviding health insurance during calendar yearsbeginning on and after January 1, 2014. Further,




they believe that since the fee will be paid inSeptember of each year, there should be no liabilityremaining at year-end. Illinois commented that theyagree with interested parties.

A concern was raised that recording the expense in2014 and then setting up the accrual for the 2015expense as of year-end 2014 will cause doubling-upof expense in 2014. However, some regulatorsbelieve that because companies will be “given abreak in 2013” (i.e. not recording a liability), thenthe double recording in 2014 is reasonable andshould not change the accounting going forward.Other regulators stated they would be willing toaddress the “double hit” by a possible phase-inapproach or other measures.

The working group next heard from interestedparties that some insurers are starting to bill the feesin the 2013 approved rates. The working group notedthat companies will begin collecting fees in 2013 thatare linked to services for 2014 and not accruing aliability in 2013. A request was made during the callfor the NAIC staff to conduct a quick survey toinquire what states are doing in terms of collection offees for 2013 that relate to 2014 since it was notedthat some states allow collection of up to 6 months in2013 while other states allow 12 months ofprepayment. Additionally, information will besought from the states on what companies are doingwith the 2013 rates (i.e. whether the ratesincorporate the fee). The sense is that there is noconsistency on rates among states. This is the firstdiscussion in which it appears the issue may haveexpanded from a tax/assessment issue into apremium revenue recognition issue because of theway the fee is built into rates.

At the end of the meeting the alternatives to beconsidered for exposure were summarized asfollows:

No accrual of the liability at year-end 2014 for2015 payments with disclosure required

Accrue the full year-end liability at year-end2014 for 2015 with a potential phase-in period

Accrue the liability for the pre-paid collected feesonly

No decision was made by the working group; thenext conference call is expected to occur in earlyJanuary.

Emerging Accounting IssuesWorking Group

At the Fall National Meeting, the working groupvoted to nullify fourteen INTs issued in 2002 and

fourteen INTs issued in 2003-2004, and include theguidance directly in the relevant SSAPs. The workinggroup exposed a proposal to move thirteen INTsfrom the 2005-2009 interpretations into the SSAPs.Comments are due February 8. The working groupalso discussed a referral from the DerivativeInvestment Reporting Subgroup regarding thetreatment of assets pledged under derivativecontracts, particularly for centrally-cleared, non-exchange traded derivatives. As the referral was notyet finalized at the time the working group met, noaction was necessary.

The working group voted January 3, 2013 via emailto expose for comment a tentative consensus, INT13-01, for a one-time extension of the 90 day rule foruncollected premium balances, bills receivable forpremiums and amounts due from agents andpolicyholders directly impacted by Hurricane/Superstorm Sandy. The extension would apply topolicies in effect as of October 29, 2012; insurerswith policyholders in areas impacted would begranted 150 days, not to extend beyond March 28,2013, before nonadmitting premiums receivablefrom those policyholders as required by SSAP 6.These receivables would still be subject toimpairment analysis. The tentative consensus isexposed until January 11 and a conference call willbe held the week of January 14 to finalize theguidance.

Capital Adequacy Task Force

Low-Income Housing Tax CreditAt National Harbor, the task force adopted the stateand federal low-income housing tax creditinvestment proposal for 2013 RBC filings. Theproposal applies a reduced factor to the property,health and fraternal formulas for LIHTCinvestments, similar to existing provisions for lifeinsurers.

ConfidentialityThe task force adopted a motion to maintain thepresent level of public disclosure of RBC results inthe annual statement. The task force had previouslyexposed a proposal and received one comment insupport of keeping the existing level of RBC publicdisclosure in the annual statement.

Revision to Timetable for Changes to RBCThe task force exposed amendments relating to thetiming of proposed changes to the RBC formulas,which would allow proposed structural changes tothe formulas that are received by the Spring NationalMeeting to be considered for adoption by the taskforce by June of the year of the effective date of the




change. Currently all structural changes must beadopted by the prior year end. During its December13th conference call, the task force adopted a revisedprocedure that any proposal that affects RBC mustbe adopted no later than April 30 in the year of thechange, which recognized the comment frominterested parties that a June adoption is too late inthe year to allow for any changes in strategy to adjustfor changes in RBC.

Securities/Broker ReceivablesThe task force exposed a letter from the AmericanCouncil of Life Insurers regarding the sale ofsecurities/broker receivables for a 45-day publiccomment period ending January 15, 2013. The ACLIletter states that the current "trade date" practice ofassigning a 6.8% RBC charge as a proxy forinvestment risk to broker receivables can lead tooverly punitive or overly beneficial RBC treatment,depending on the risk level of unsettled assets.Adopting a "settlement date" approach for RBCcalculations will result in a more accuraterepresentation of investment risk and therefore,more accurate RBC.

Working Capital Finance InvestmentsThe task force exposed a referral from the Valuationof Securities Task Force regarding working capitalfinance notes for a 45-day public comment periodending January 15, 2013. The referral recommendsthat the task force consider that WCFIs must bepreapproved by the SVO before an insurer canengage in them and that the SVO has developed acorporate methodology which would assign NAIC 1or 2 designations based on the credit risk associatedwith the corporate obligor, as it currently does forother bonds.

Restricted AssetsDuring its October 29 conference call, the task forcediscussed a referral from the Financial AnalysisWorking Group concerning a potential increase tothe RBC factor for restricted assets. The currentcharge is 1.3% of the carrying value of restrictedassets as disclosed in Interrogatory 24 in the annualstatement. After significant discussion the taskforce voted to expose for comment a proposal thatthree RBC formulas be modified to incorporate aC0/R0/H0 charge for insurers with a largeproportion of restricted assets on their balancesheets. The specific charges were not beingproposed, but rather the concept of an increasingcharge based on the level of restricted assets held,e.g. no additional charge if less than 5% of assets arerestricted, an additional 2% charge if 5-10% of assetsare restricted or pledged, an additional 5% charge if

10-25% of assets are restricted and a 10% charge ifgreater than 25% of assets are pledged or restricted.

The comment period ended December 3 and duringits December 13 conference call, the working groupheard comments from four parties who all stronglyobjected the proposal, including the IowaDepartment of Insurance. The task force agreedmore time was necessary to study the issue anddeferred a vote that would have made the structuralchange effective for 2013.

RBC Think TankAt the Fall National Meeting, the formation of an“RBC Think Tank” was announced, which purpose isto take an overall view of the work being done by allthe RBC groups, with a focus on the use of the AAA’sresources and whether the groups are working onthe appropriate issues. The Think Tank is comprisedof the chairs of the working group and NAIC staff,including Lou Felice, former chair of the CADTF.

C-1 Factor Review Subgroup

The subgroup continues to consider a recalibrationof C-1 factors used in the RBC calculation. The C-1factors are intended to capture an asset's risk ofdefault of principal and interest or fluctuation in fairvalue. These factors have not been updated since1991. The subgroup met frequently throughout 2012,with much of the discussion focused on the bondmodeling project being led by the AAA, which hasdeveloped a bond model which replicates the 1991model, such that when using the 1991 scenarios andassumptions, the new model generates the same orvery similar C-1 factors.

Since the Summer National Meeting, the AAA hasdevoted significant attention to determining theappropriate assumptions and developingrepresentative bond portfolios of 400-600 securitiesto be used in the model. The AAA has tentativelydetermined that it will use Moody’s cumulative bonddefault rate data based on experience over the last10-years. The AAA had considered using data over alonger period; however, the volume of belowinvestment grade issues has increased significantlyin the last 10 years, providing for more data.Moody’s default data is aggregated based on 13ratings categories, as a result the AAA noted that itwill likely recommend expanding the current 6 NAICratings designations to either 12 or 13.

At the Fall National Meeting, the AAA discussed itsconsideration of recovery assumptions. The AAA has




identified issues with how to assess subordinationwithin debt structures and whether considerationshould be made at the issue or issuer level, notingthat certain data is only captured at the issuer level.The AAA plans to have calls with bond experts toresolve both issues. It had been expected that thesubgroup would be in a position to endorse the AAAmethodology and assumptions by February 1, 2013.The subgroup was then expected to consider theresults of the bond modeling, and decide by March31, whether to expand the number of NAIC ratingsclasses. However, in National Harbor, the Academyrepresentative acknowledged that they were fallingbehind the “optimistic” project plan timeline. It istherefore likely that this project will extend furtherinto 2013.

The subgroup also received updates from subgroupmembers on their consideration of the followingasset classes: common stock, mortgages, real estate,derivatives and other invested assets. Once thesubgroup has completed its work, it will make aproposal to the Capital Adequacy and Valuation ofSecurities Task Forces, with a goal of implementingthe revised C-1 factors for the 2014 RBC calculation.The subgroup plans to continue to hold bi-weeklyconference calls over the next several months tocontinue its discussions.

SMI RBC Subgroup

The subgroup met by conference calls in September,October, and December and in person in NationalHarbor. A significant part of the subgroup'sdiscussions relate to operational risk and acomparison of the international regimes’ treatmentof operational risk. It was discussed that operationalrisk charge increases for insurers with substantialchange, positive or negative, in their premiumvolume. The factors vary by regime and it appearsthat the life operational risk factor is higher than thenon-life or the other way around, depending on theregime. Bermuda varies its operational risk factorcharge by its equivalent of an RBC ratio. Mostregimes use a premium based or reserve basedcalculation and for others, it is based on specifictypes of business.

In response to a request from the working group toidentify risk correlation methodologies used todetermine regulatory solvency capital requirementsin advanced jurisdictions outside the U.S., the AAAissued its report in November entitled "DependencyStructures in Risk-Based Capital: Summary ofMethodologies Used by a Variety of Jurisdictions to

Reflect Risk Correlation in Property/CasualtyStandard Formulas." The report indicates that theU.S. RBC formula is simple to use; however, to anoutsider, it is not easy to understand and requires asignificant amount of data including some that is notavailable in the NAIC annual statement. The currentRBC correlation structure constitutes judgments andif correlation factors could be calibrated withsufficient accuracy, the formula becomes more risksensitive. Bermuda's overall correlation structure issimilar to the U.S. The AAA report also reviews themethodologies used by Canada, Australia, SolvencyII and the Swiss Solvency Test.

The working group discussed that life RBC includesa business risk charge which some may refer to as anoperational charge or a catch-all charge based onpremiums; the property/casualty RBC has a growthcharge; and the health RBC also has a growth chargewhich relates the growth in RBC to the growth inpremium. Thus, a question remains regarding theextent of operational risk charge that is embedded inexisting charges. The working group discussed theneed to develop useable definitions of operationalrisk before developing an operational risk charge. Aregulator commented that the risk charge is notspecific by company but rather by the product linebeing sold.

The working group also heard a presentation by theOperational Risk Consortium where it was discussedthat operational risk, as defined by Basel II andimposed on banks, is the risk of loss resulting frominadequate or failed internal processes, people andsystems or from external risks. Operational risk doesnot include underwriting, strategic or reputationalrisks, but includes legal risks. Operational risk isperhaps the most significant risk faced by thefinancial services industry. The chair stated theworking group is “highly motivated” to have anoperational risk charge in the RBC formulas, and willcontinue to study different methodologies to captureoperational risk.

Life Risk-Based Capital WorkingGroup

The working group met via conference call inOctober and November and again in NationalHarbor with the primary goal of reaching consensuson the ACLI commercial mortgage proposal, whichwas officially exposed for public comment for thefirst time on the October 26 call.




The most controversial issue in the ACLI proposalcontinued to be the use of a standardized 25 yearamortization period for debt service coverage, whichthe ACLI believes will "level the playing field"between different types of loan structures and ismuch less complex than using the actualamortization period for individual loans. Someregulators and the NAIC Capital Markets Bureaubelieve that not using actual amortization periodsmight encourage manipulation of the system.However, after significant discussions with the ACLIin November, the Capital Markets Bureau agreed tothe use of standard amortization tables, but with thefiling by life insurers of “additional data points”including the actual amortization and coupon ratefor individual loans. The exact detail of the newdisclosures and the format for filing, e.g. as a newschedule filed with the confidential RBC report, hasnot been exposed for comment. The ACLI and theBureau also agreed to use a three year weightedperiod for both discounted cash flows and loan-to-value with the current year being weighted 50%, theprior year 30% and the second prior year 20%.

During its meeting in National Harbor, the chairnoted that the current factors in the ACLI proposalwould result in a 30% decrease in RBC held forcommercial mortgages compared to the currentMEAF methodology. Several working groupmembers suggested revising the proposal factors toreduce the level of the decrease. No final decisionwas made with respect to this issue at the FallNational Meeting. The ACLI’s proposed five new riskcategories for commercial loans in good standing,are.9%, 1.75%, 3%, 5% and 7.5% for CM1 throughCM5, respectively.

The working group and interested parties had beenworking at a very accelerated pace all summer andfall with the intent of having a completed package bythe end of 2012 in order for the new commercialmortgage RBC proposal to be in effect for 2013.With the resolution of the standard amortizationperiod issue discussed above, and the working groupreserving the right to increase the factors before thefactors are finalized, the working group votedunanimously in National Harbor to adopt thestructure of the ACLI commercial mortgage proposalfor 2013 Life RBC. The working group hadanticipated holding at least one additionalconference call in December to resolve open issues,but with the change in the procedures for adoptingrevisions to RBC as late as April 30 of the currentyear (as discussed above in the CADTF summary),that work was not considered necessary by year-end

2012. The next conference call of the working grouphas not yet been scheduled.

Property/Casualty Risk-BasedCapital Working Group

On November 1, the working group held aconference call to continue its discussion on areferral from the Risk Retention Group Task Forcerelating to additional guidance for RRGs in theProperty and Casualty RBC Instructions. The needfor additional guidance is arising from implicationsfor RRGs in completing RBC reports due to the factthat many RRGs utilize an accounting basis otherthan statutory accounting principles (SAP) and theNAIC RBC formula was developed based on theapplication of SAP. The chair discussed an issue shehad just been made aware relating to discounting ofloss reserves; if an RRG discounts its loss reservesand those discounted reserves are used in the RBCformula, then the application of the investmentincome offset factor would cause double-counting ofthe discount. The working group was informed thatit is not uncommon for not-for-profit RRGs todiscount loss reserves.

Following discussion by the working group, it wasdetermined that Vermont would undertake anassessment of the appropriateness of the draftproposal for not-for-profit entities, ensuring that theproposal does not adversely affect the NFPs' RBCand tax status. Discussion of this matter willcontinue in the next conference call planned forJanuary 2013.

The working group discussed an industry commentregarding an inconsistency between the instructionsand the formula in calculating the insuranceaffiliates that are subject to RBC. The working groupdiscussed whether it would be appropriate to changethe instructions to match the formula and it wasdetermined that a review of the issue is needed, andas such, regulators and interested parties were urgedto provide comments to NAIC staff prior to the nextconference call.

The working group then discussed the long-standingissue of the 10% Credit Risk Charge for ReinsuranceRecoverables, which many in the industry think istoo high, considering the charge used by the ratingagencies in their formulas is 1-2% per the RAA andapplies even when the recoverable is fullycollateralized. The RAA representative also notedthat this issue has resurfaced because the currentcatastrophe risk charge proposal is also using 10%




for reinsurance receivables and that this applicationof the 10% would exacerbate the problem.

The regulators noted that the flat 10% chargeincludes some risks that are difficult to quantify. TheAmerican Academy of Actuaries agreed that some ofthe components in the credit risk are unquantifiable.The working group asked the AAA to prepare a shortwhite paper to list all the issues and questionssurrounding this topic and recommended chargesfor the risks that are quantifiable. For those risksthat are hard to quantify, a recommended judgmentfactor could be applied. AAA noted that in theory,the credit risk charge for catastrophe might behigher than regular credit risk charges because therisk for reinsurers to go bankrupt is higher if asignificant catastrophe happens. Research indicatesthat companies that use more reinsurance thanothers have a greater risk of insolvency. The workinggroup will continue its discussion of the issue in thenext conference call.

Lastly, the working group was informed that theissue of the underwriting risk factors is still beingreviewed by the AAA and the Casualty ActuarialSociety and updates will be provided in the nearfuture.

Catastrophe Risk Subgroup

On September 17, the subgroup held a conferencecall to discuss the timeline for implementing theRBC catastrophe formula on an informational-purpose only basis for the 2013 RBC reporting. Thetask force will need to approve the revised R5underwriting risk factors on an "ex-catastrophe"basis by June 30, 2013. The factors cannot bedeveloped until data on actual catastrophe losses for2012 has been collected and analyzed. The task forcehad previously approved the collection of insurers’actual U.S. hurricane, tropical storm and earthquakecatastrophe loss data in the 2012 RBC reporting. Inaddition, the subgroup had previously agreed tocollect non-U.S. catastrophe losses in the same levelof detail as U.S. catastrophe losses, separatelythrough an informal process by the NAIC staff. It isanticipated that the revised “ex-cat” R5 underwritingrisk factors will be calculated based on the collecteddata in March 2013 and exposed for comments inApril 2013. The subgroup heard that calculation ofthe indicated “ex-cat” factors will not be a difficulttask to accomplish; however, because there aresignificant differences between the existing indicatedand selected factors, developing a method for

choosing the selected “ex-cat” factors will need to beworked through in the near future.

During a regulator call on October 11, the subgroupvoted to expose changes to the RBC formulaspreadsheets to incorporate property catastropherisk on an information-only basis for the 2013annual statements. Minor changes to the proposalwere made resulting from comment letters receivedand the revised proposal was re-exposed.At National Harbor, the subgroup discussedcomments received and adopted the catastrophe riskformula proposal.

Also at National Harbor, the subgroup discussed acomment relating to pooling and reinsurancearrangements. It was noted that PR025 requiresmodel catastrophe losses to be reported gross ofreinsurance and net of reinsurance on a legal entitybasis. PR025 also requires "catastrophe losses thatwould be ceded to reinsurers that are not subject tothe RBC credit risk charge." It was pointed out thatmany insurance groups conduct business throughintercompany pooling agreements and/or through100% intercompany quota share reinsuranceagreements. These insurance groups do not modelcatastrophe losses on a legal entity basis and thus,would have to allocate modeled catastrophe lossesfrom a pool basis. The subgroup determined thecomment worthy of consideration and held aconference call on December 6. During the call, thesubgroup discussed the inclusion of interrogatorieson PR025, thus exempting companies with pooling/reinsurance agreements from calculating thecatastrophe risk charge. On December 10, thesubgroup adopted the revised PR025 and onDecember 13, the task force adopted the revisedPR025 of the Catastrophe Risk Formula Proposal for2013 RBC Reporting.

As a follow-up to the changes to the 2012 PropertyRBC report as approved by the task force during theSummer National Meeting, the subgroup issued anFAQ document on November 14 which wasdiscussed at the Fall National Meeting. For year-end2012 Property RBC reporting, companies arerequired to provide U.S. catastrophe losses byannual statement Schedule P line of business in theconfidential Schedule P RBC filings. Catastrophelosses are cumulative incurred to date net losses only(no expenses) as of December 31, 2012 for accidentyears 2003 through 2012 as well as total netcatastrophe losses unpaid as of December 31, 2012.A "catastrophe" is defined for this purpose as arisingfrom events numbered and labeled by PropertyClaim Services (PCS) as a hurricane, tropical storm,




or earthquake. The data will be collected via twoadditional columns in the existing Schedule P Part 1confidential filings. The requirements for the data tobe reported in the existing columns have notchanged; that is, net earned premiums, net lossesand expenses unpaid, and net losses and expensesincurred by line of business wwould continue to bereported as per existing requirements.

In addition to the required 2012 filing of U.S.catastrophe losses, companies are requested toprovide the same information for non-U.S.catastrophe losses, to the extent possible, viaseparate 2012 reporting forms, as adopted by thesubgroup on December 11. Non-U.S. catastrophelosses are defined as arising from a hurricane,tropical storm, or earthquake that meets a $25Mindustry threshold as published by Swiss Re Sigmaor Munich Re Nat Cat Service. The 2012 reporting ofnon-U.S. catastrophe losses is strictly voluntary. Thisdata is intended to be used by regulators to developex-cat premium underwriting charges for use withinthe catastrophe risk charge component of the RBCformula that will be reported on an informational-only basis beginning with 2013 reporting in order toavoid double counting of catastrophe losses. Thisdata will be held confidential in the same mannerthat all data submitted as part of annual RBCreporting is held confidential.

Lastly, during the Fall National Meeting, thesubgroup approved the Applied Research Associates,Inc. HurLoss Model and Florida Public Model asallowable hurricane loss models.

Health Risk-Based CapitalWorking Group

The working group met by conference calls onNovember 13 and December 17, and did not meet inNational Harbor. During the calls, the working groupcontinued its discussion of health care receivablefactors including the American Academy ofActuaries' recommendation to augment thereporting of these receivables in the Underwritingand Investment Exhibit Part 2B, by adding a newSection B entitled Analysis of Health CareReceivables. The proposed change would provideadditional detail on the six types of health carereceivables, and would provide data for a follow-upstudy of the health care receivables. The proposalwould provide information for future analysis to thesufficiency of the current RBC factors, higher qualityfinancial disclosures, and provide for a moremeaningful study of claims. AAA is recommending a

proposed implementation date of 2013. AAA willthen use the year-end 2013 data for analysis of thehealth care receivable factors in 2014. The proposednew Section B has not yet been exposed forcomment.

The working group received an update from asubgroup of AAA relating to RBC factors for theMedicare Part D Supplemental benefits. It wasreported that factors related to benefits for definedstandard benefit plans appear reasonable. However,data issues on the supplemental benefit programshave delayed the completion of this study. Theworking group hopes to have a recommendation byAAA by May 2013.

The working group continues to monitor the impactof Affordable Care Act on the Health RBC formula.There is currently a delay in the readiness for theexchanges, and from an RBC perspective thisincreases the risk for companies because thegovernment still plans for companies to beginoffering and selling in October 2013, policieseffective January 1, 2014. The working groupdiscussed a study conducted by the Health ActuarialTask Force Risk and Reinsurance Subgroup toidentify those aspects of the ACA that may have amaterial effect on the risks. It was noted that some ofthe impact identified may be temporary, thuscreating a complex and difficult question of how totreat risk-based capital in the context of these veryrisky changes that are coming. A suggestion wasmade to request comments from industry to guidestates that are monitoring solvency in these unusualtimes. A comment was made that because there areinteractive effects of various items in reinsurance,risk adjustment and risk corridors, it is important tolook at other provisions of the ACA. There are somemitigating factors with reinsurance, risk adjustment,and risk corridors, but depending on how riskadjustment is implemented, it could have asignificant impact on small companies with healthyblocks of business. The concern is a one-timeconcern, but if a small company renews anunderwritten block of business in 2013 and the ratesare still effective in 2014, then the company will haveto pay out risk adjustment amounts, which couldhave some impact on their solvency.

The working group also discussed issues related toindustry segment concentration risk. AAA hasdeveloped a model indicating that more RBC isneeded for those insurers who have businessconcentration. The model is for administration costitems arising from concentration risk, and attemptsto calculate the loss of a large block of business that




occurred quickly because the carrier wasconcentrated in a particular industry or customer. Aprimary solvency concern would be the ability tocover fixed expenses. AAA was asked to comment onincreased utilization concentration risk when a largecontract is lost. AAA noted that it would depend onwhy the business went away. If the business went toanother carrier, then increased utilizationconcentration risk is not a concern. However, ifeveryone in the industry lost their job at the sametime and they had only a few months to use theirhealth care coverage, then increased utilizationconcentration risk would be a concern and it wouldbe worthwhile to have others look at the line ofbusiness factor. AAA commented it did not have anydata to estimate or quantify this risk.

AAA provided an update on underwriting risk andinvestment risk. Utilizing data provided by NAIC,AAA calculated the H1 asset risk and compared it tothe change in H2 underwriting risk, noting that theredid not appear to be correlation. On November 20,the working group formally requested for AAA toreview the correlation of market valued investments,such as equities, mutual funds and other equity-likeinvestments to the underwriting risks and losses thatmay have an impact on capital adequacy.

During the November 13 call, the working groupnoted that NAIC staff was drafting a survey relatingto pandemic and bio risk. The draft survey wasdiscussed during the December 17 call, which callsfor companies to comment on whether they allocatea component of surplus for pandemic or bio risks;whether modeling is used and if so, a description ofthe modeling; and whether a computation exists andif so, a description of the computation.

IAIS 2012 Annual Conference

The International Association of InsuranceSupervisors (IAIS) held its annual conference fromOctober 10-12, in Washington DC, hosted by theNAIC. The conference was attended by regulatorsand observers from around the world, includingmany U.S. companies and industry associations.Discussions at the conference revolved around thefuture of insurance regulation and supervision, andthe IAIS’s role in shaping this.

ComFrame was a significant topic of discussion atthe conference. Regulators and industry both viewComFrame as a critical project to update supervisorypractices, which regulators recognized need to

develop in order to regulate sophisticated insurancegroups. There was consensus that ComFrame willneed to balance flexible principles with moredetailed rules and guidance, and that it should avoidbeing overly prescriptive. Group capital was alsodiscussed at length, with some regulators favoring amove towards a global capital standard forInternationally Active Insurance Groups (IAIGs).U.S. regulators were supportive of a system to assessthe financial health of IAIGs, but spoke stronglyagainst the use of a global capital standard to achievethis objective, for reasons including its potentialinfringement on the powers of a local supervisor,and the lack of a consistent global accounting basisfor insurance contracts. The increasing importanceof Colleges of Supervisors was also discussed at theconference, although there was debate on the role ofthe group supervisor, and whether there should bedefined powers associated with this role.(Developments around ComFrame since the IAIS2012 Annual Conference, including several of the keytopics discussed in Washington DC, are summarizedunder the International Insurance RelationsCommittee, below.)

Financial stability issues were also discussedextensively. There was broad agreement that themeasures applied to banks should not be mappeddirectly to insurers, which have a substantivelydifferent business model and risk drivers, and bothregulators and industry agreed that non-traditionaland non-insurance activities are the primarypotential sources of systemic risk for insurers.

It was recognized at the conference, however, thatfurther work will be required to establish the policymeasures that will be applied to Global SystemicallyImportant Insurers. Shortly following theconference, the IAIS released its proposed policymeasures, for public consultation until December16.1 The proposed policy measures are describedfurther under the International Insurance RelationsCommittee, below.

Supervision of consumer protection issues, currentlyan important topic of discussion among Europeanregulators, was also discussed at the conference.Discussions were also held on the supervision ofemerging markets, micro-insurance, the Access toInsurance Initiative, and longevity risk.

Alongside the IAIS Annual Conference, the EU-U.S.Dialogue Project Steering Committee also held a

1

http://www.iaisweb.org/view/element_href.cfm?src=1/16648.pdf




public hearing on the reports prepared by its seventechnical committees comparing certain aspects ofthe EU and U.S. regulatory regimes.2 The SteeringCommittee was comprised of Terri Vaughan, KevinMcCarty, Michael McRaith, Karel Van Hulle, EdwardForshaw and Gabriel Bernardino, representing theU.S. and EU regulatory systems respectively. Asecond public hearing was held four days later inBrussels.

The Steering Committee heard comments fromindustry organizations and political representativesfrom the EU, U.S. and Bermuda. Many of thecomments concerned reinsurance collateralrequirements for alien reinsurers in the U.S., a majorpoint of difference between the two regimes, and aperceived inequality given that no collateralrequirements are imposed on alien reinsurers bymost EU countries.

While the collateral requirements are reduced by thenew Credit for Reinsurance Model Law and ModelRegulation (#785 and #786), it was noted that thecollateral reductions are not mandatory foraccreditation. The perceived difficulty and timeinvolved in implementing new model laws andregulations consistently across the states was alsodiscussed, and it was noted in this context that theformer collateral requirements currently remain inplace across the majority of states. Regulators’ datacollection and analysis capabilities were alsodiscussed, and were generally recognized as beingstronger in the U.S. than in the EU. Commentatorsdid also note areas in which the EU and U.S.regulatory systems appear to be well aligned, basedon the report, including professional secrecy andconfidentiality measures.

The EU-U.S. Dialogue Project is a long-standingdialogue between the two regions, and the SteeringCommittee reinforced the message at the publichearings that its report is not connected to anyquestions around Solvency II equivalence. However,many commentators drew a link, and urged theSteering Committee to use the report to pave a clearpath to equivalence.

Further updates on the EU-U.S. Dialogue Projectwere discussed at the NAIC Fall National Meeting,

2

https://eiopa.europa.eu/fileadmin/tx_dam/files/consultations/c

onsultationpapers/EU_US_Dialogue_Project_Report_for_Consu

ltation.pdf

and are summarized under the InternationalInsurance Relations Committee.

Solvency ModernizationInitiatives Task Force

The NAIC’s SMI Roadmap anticipated that all majorpolicy decisions would be completed by the end of2012, so as the last NAIC National Meeting of 2012,the meeting at National Harbor represented animportant milestone for the SMI working groups.Based on discussions there, many of the SMIworkstreams will continue beyond the end of thisyear, and the task force approved its charges for2013. The task force also instructed NAIC staff toupdate the SMI Roadmap, which was distributed bythe NAIC on December 21.

SMI White PaperThe task force has continued work on its white paper"The U.S. National State-Based System of InsuranceFinancial Regulation and the SolvencyModernization Initiative." The task force discussedredrafting work to the first four sections of the whitepaper, drawing attention to a number of areas ofprevious industry comment, none of which receivedsignificant discussion at the National Meeting.

At the Summer National Meeting, the task force hadheard comments from interested parties thatassertions made in the white paper about thestrength of the U.S. regulatory system should besupported with evidence, and the task force thenasked the American Academy of Actuaries to outlinemethods of measuring regulatory financial success.In National Harbor, the AAA presented a reportrecommending a series of qualitative andquantitative indicators for regulatory success, whichthe task force agreed to expose for a 30 publiccomment period.

In National Harbor, the task force noted its intentionto complete the first four sections of the report sothat it could move on to the SMI section, which isexpected to document policy decisions arising fromthe SMI.

PBR Working Group

At its joint meeting on the final day of the FallMeeting, the Executive Committee and Plenarynarrowly adopted the PBR Valuation Manual, with43 votes in favor of the motion. The VM required asupermajority adoption, needing 42 affirmativevotes out of a possible 56. The newly adopted VM,




with the 2009 revised Standard Valuation Law andthe Standard Nonforfeiture Law for Life Insurancewill begin to be presented to 2013 legislatures as apackage. In order for PBR to become effective, thepackage must be adopted by at least 42 jurisdictionsrepresenting at least 75% of the subject premium.The prospect of attaining the 75% of premiumthreshold may have dimmed with both Californiaand New York voting against the proposal. Ifultimately effective, the new requirements wouldphase in over 3 years from the effective date and arecurrently applicable only to new business issuedafter the effective date. States and territories votingagainst the proposals were California, Guam,Maryland, New Mexico, New York, North Carolina,Oregon and Wyoming. Minnesota and Oklahomaabstained, and the Northern Mariana Islands, PuertoRico and South Carolina did not vote.

Alongside the adoption of the VM, members alsovoted to elevate the PBR Working Group to anexecutive-led joint working group of the LifeInsurance and Annuities and Financial ConditionCommittees, which will work on guidelines to ensurethat there are adequate resources for states toimplement PBR, in addition to working ontransitioning reserving practices, data compilationand engaging consumers.

Representatives from New York and California spokeagainst the adoption of the VM. California noted thatit is not opposed to PBR, but presented three areasof further analysis which it recommended should becompleted before PBR is presented to statelegislatures: fiscal analysis and how the cost of PBRwill be met; resource requirements for the states toimplement PBR; and collaboration procedures forthe NAIC. California shared its own experience ofreviewing insurers’ internal models, noting thatspecialist modelling experts are needed to reviewcomplex models, which states may not have on theirstaff.

New York presented both technical and structuralarguments against PBR at the meeting, consistentwith a letter that it sent to the NAIC on November26, urging commissioners not to vote in favor ofPBR.3 New York questioned the timing of PBR,which it expected to result in reserve reductions inthe aggregate at a time of economic stress and lowinterest rates. New York also argued that aprinciples-based reserving regime had resulted inlower reserves for banks, which contributedsignificantly to the financial crisis. New York also

3 http://www.dfs.ny.gov/insurance/life/pbr_ny_11262012.pdf

suggested that the implementation of PBR may beperceived as deregulation and the lessening ofconsumer protection, and insurance regulatorswould likely be blamed in the event of any futureinsurer insolvency. New York also questionedwhether the lower reserves that it expects to bepermitted by PBR would provide any benefit toconsumers in an already highly competitive andaggressively priced life market.

New York further expressed concern about theresources needed to implement PBR properly, andadvised that thorough and comprehensive planningshould be carried out to ensure that PBR, itsadministration and its implications are fullyunderstood before replacing the current rules-basedregime.

Several other members of the NAIC, includingDelaware, the District of Columbia, and Texas alsospoke at the meeting. Most agreed that moredetailed implementation planning would be requiredto implement PBR, but argued that the adoption ofthe VM was necessary to show that U.S. state-basedregulation is adapting and moving forward and toshow effective leadership by the NAIC. The proposednew joint working group would be a resource tocarry out more detailed planning, which speakersargued could be implemented effectively followingadoption of the VM.

The PBR Working Group discussed a draftimplementation plan for PBR, which includesupdating the detailed PBR implementation plan andtimeline created in 2008, and that theimplementation process will involve coordinationwith the Life Actuarial Task Force and a number ofother NAIC working groups and committees.

The draft plan covers key issues and policy decisionsto implement PBR. Recognizing that adequateresources will be vital, the draft plan proposes thatthe working group will conduct a survey of the stateson their current level of resources, anticipatedresources to support PBR, and the expected costs ofand potential for obtaining the necessary resources.In addition, the draft plan recommends the creationof two major components to support PBR review andupdating process; an NAIC Actuarial Resource(comprised of a combination of NAIC actuarial staffand consultants) and a new NAIC working group(Actuarial Analysis Working Group). The roles of thenew resource and working group would supportstate and NAIC activities for PBR implementationand ongoing review. The draft plan also considersthe statistical data collection that will be required for




PBR, and recommends a phased introduction of datacollection over 3 years, most likely starting with lifepolicy data. The draft plan recommends that datacollection be in place for annual 2015 reporting.

The draft plan also notes that the implementation ofPBR will require changes to current reportingschedules, and for new schedules to be developed,including the collection of a greater granularity ofproduct information, the amount of public versusconfidential data, and the NAIC’s automatedfinancial analysis and prioritization tools. Further,the draft plan notes that the NAIC is working onaccessing the default and bond bid-ask spread datathat will be required to implement the VM, fromrating agencies and broker-dealer sources.

The draft plan recognizes the importance ofproviding training for state insurance departmentstaff, and proposes an online training program forlate 2013 or early 2014. In addition, the draft planalso proposes that the NAIC develop training on VM-specific actuarial topics, and considers that furthertraining will also need to be developed as PBR isimplemented, including for analysts and examinersas the relevant tools and handbooks are updated.

The working group agreed to expose the draft planfor public comment until January 10. The workinggroup also asked interested parties to suggestquestions for its survey on state resources. During itsmeeting, the working group heard industrycomments on PBR, including the need for dueprocess around updates to the VM, adequateresources, and coordination with other workinggroups.

Group Solvency Issues WorkingGroup

Own Risk and Solvency Assessment (ORSA)As anticipated at the Summer National Meeting, theworking group held a joint conference call with theFinancial Condition Committee in September, whichwas shortly followed by a joint meeting of theExecutive Committee and Plenary. At both of thesemeetings, the Risk Management and Own Risk andSolvency Assessment Model Act (#505) wasunanimously adopted.

The final version of the model act was substantiallyunchanged from the version discussed in Atlanta.New wording was introduced to strengthenconfidentiality protection where the ORSA SummaryReport is shared with the NAIC or third party

consultants, which requires the commissionersharing the report to obtain written agreement fromthe recipient to maintain confidentiality, andconfirmation that the recipient has legal authority todo so. Sharing with other state regulators is alsorestricted to states in which the group providing thereport has a domiciled insurer. The adopted draftalso retains the requirement, discussed extensivelyon working group conference calls over the summer,for an insurer subject to the act to maintain a riskmanagement framework.

When adopted by the states, the model act is set tobecome effective on January 1, 2015, with the firstORSA Summary Reports filed in 2015. Insurancegroups are required to file the report annually totheir lead state regulator, with individual insurersrequired to provide a report on request, but no morethan once annually. Drafting guidance in the modelact indicates the intention for all insurers to submit areport annually, with a flexible submission datedepending on the insurer’s internal strategicplanning process.

At its meeting in National Harbor, the workinggroup discussed proposed recommendations to theFinancial Regulation Standards and AccreditationCommittee, for Part A accreditation standards andguidelines for the new model act, including sectionsthat should be considered significant elements. Theworking group agreed to expose therecommendations for a 45 day comment periodending January 14, 2013.

Additional work on the ORSA was also carried outover the fall by the ORSA Subgroup, as detailedbelow.

Holding company analysisThe working group discussed holding companyanalysis by conference call in October, and received afurther update in National Harbor. On its interimconference call, the working group noted thatadditional guidance on the states’ responsibilities forholding company analysis appeared to be required,and the working group therefore voted to make arequest to the Financial Regulation Standards andAccreditation Committee to extend the effective datefor the holding company analysis accreditationstandards and guidelines from January 1, 2012 toJanuary 1, 2014. The proposal was adopted by thecommittee later in October. The working groupnoted on its conference call that its intention inmaking the recommendation was to provide extratime for states to work on analysis processes andprocedures before being scored by the accreditation




team, rather than for states to stop holding companyanalysis, or for the accreditation team not to providefeedback on completed analyses, in the meantime.

The working group also heard in National Harborthat revisions to the Financial Analysis Handbookrelating to holding company analysis had beenadopted, and that a webinar to clarify the states’responsibilities had been conducted.

Group supervisionIn National Harbor, the working group discussed thedesignation of a single lead state for groups whichcurrently have more than one designated lead state(the working group heard that this applies toapproximately 15% of groups). A single lead statewas considered to provide a useful single contactpoint for international regulators, and was alsoconsidered to be useful for groups themselves. Theworking group agreed to charge NAIC staff to workwith the states to establish a single lead state foreach group.

The working group also charged NAIC staff todevelop a new section for the Financial AnalysisHandbook that explains the U.S. state regulatoryapproach to group supervision, and the role of thelead state regulator. The working group also askedinterested parties to provide any input orsuggestions for the new section by December 31. Thenew section is intended to clarify the U.S. approachto group supervision to international regulators andother parties.

ORSA Subgroup

The subgroup met by conference call in November,and discussed and adopted its report on the ORSApilot study conducted over the summer. The pilotstudy involved the review of 14 ORSA SummaryReports submitted by volunteers. Of these, 9 reportswere considered complete, of which 3 includedcomplete data. Two submissions included aframework only, and 3 submissions omitted entiresections. The report was later adopted by theFinancial Condition Committee in its meeting atNational Harbor. The results of the pilot study aresummarized in PwC’s NAIC Summer Meeting NotesNewsletter.

The subgroup recommended that the languageshould be aligned between the ORSA GuidanceManual and the Risk Management and Own Riskand Solvency Assessment Model Act (#505), andproposed a number of other drafting suggestions to

clarify technical language and intent. These includedproposed guidance for insurers to include asummary of material changes to the ORSA from theprior year and that the insurer should provide acomparative view of risk capital from the prior year.During its November conference call, the subgroupvoted to expose the amended draft for a 60 daycomment period.

The subgroup also recommended referrals to theFinancial Analysis Handbook Working Group andthe Financial Condition Examiners HandbookTechnical Group, which are intended to start thedrafting of guidance for regulators of the review ofERM and the ORSA submitted by companies. Thesubgroup recommended that it continue to beinvolved, in order to provide expertise and guidance.Matters that the subgroup recommended beconsidered include:

The goals of the examination. The impact on existing examination plans and

procedures, including scope, focus, the need fortarget examinations, the potential for groupexaminations, and the impact on holdingcompany analysis procedures.

Resource constraints. Interstate, intrastate and international

coordination, and the role of the lead state.

The referrals also recognized that, due to the natureof the ORSA, a “checkbox approach” to review wouldnot be appropriate. Given the referrals made, thesubgroup further recommended that the FinancialCondition Committee wait to consider the need forPart B accreditation standards until afterexamination and analysis guidance has been fullydiscussed.

Finally, the subgroup recommended performing asecond pilot exercise in 2013, which the subgroupbelieves would help in the drafting of guidance onthe regulatory review of ORSA Summary Reports.The subgroup did not meet in National Harbor.

Corporate Governance WorkingGroup

The working group met twice by conference callduring the fall, and met at the Fall National Meeting.

Corporate governance comparative analysisAt its meeting in National Harbor, the workinggroup discussed and agreed to expose for publiccomment updated drafts of its proposed Exhibits A,




B, and E from its document Proposed Response to aComparative Analysis of Existing U.S. CorporateGovernance Requirements. The working group haddrafted the response document, including theproposed exhibits, to recommend enhancements toU.S. corporate governance regulation following itsreview of current U.S. requirements, and hadpreviously exposed it for a public comment periodending in September, 2012. The document willinform the working group’s final conclusions andrecommendations on corporate governance policydecisions, which it was expecting to provide to theSMI Task Force in National Harbor. However, thetask force agreed to make a request to the SMI TaskForce, which the task force approved later at the FallNational Meeting, to delay delivery until the SpringNational Meeting.

The working group had received extensive (andstrongly worded) comments from interested partiesin response to its September consultation, which itdiscussed on conference calls in October andNovember, and which the group considered inproducing the revised draft exhibits exposed inNational Harbor. In its discussions, the workinggroup particularly emphasized that its proposals willnot be finalized on adoption by the working group,and that its proposed Exhibit E on a proposedcorporate governance template in particular is likelyto go through an extended development process.

A summary of each of the exhibits exposed forcomment is provided below:

Exhibit A: Narrative filing covering four topicareas: a general description of the corporategovernance framework; the board of directors andcommittee policies and practices; managementpolicies and practices; and management andoversight of critical risk areas. Discussion ofsignificant changes from prior year is also included,to allow insurers to file the report unchanged year-on-year where no significant changes have occurred.Discretion is provided as to whether information isprovided at ultimate parent, intermediate holdingcompany or legal entity level, to allow the disclosureto be aligned to the level at which corporategovernance oversight is provided to each legal entityrequired to submit the filing.

Exhibit B: Proposed annual statement schedulecovering compensation paid to officers, employeesand directors, aggregate compensation, andinterrogatories. The exhibit would requiredisclosures similar to those currently required by the

SEC with narrative discussion of compensationpractices covered by Exhibit A.

Exhibit E: A common assessment methodology forcorporate governance, which the working grouporiginally envisaged would include a standardizedassessment template, ratings methodology andfollow-up procedures. The three proposals all metwith significant pushback both from industry andfrom some members of the working group, whosuggested that the NAIC should wait for a few yearsbefore developing a standardized methodology,when regulators have more experience reviewingcorporate governance issues. The exhibit exposed forcomment at the Fall National Meeting thereforemakes referrals to the Financial Analysis HandbookWorking Group and Financial Examiners HandbookTechnical Group, asking those groups to startconsidering the development of a commonmethodology, but recognizing that this will be alonger-term project.

A particularly significant area of discussion betweenthe working group and industry over the fall was theconfidentiality of any new corporate governancefilings, and this topic was regarded as critical by bothregulators and industry. The working groupdiscussed potential options to maintainconfidentiality on its November conference call,including modifications to existing models, creationof a new model, or collection through the annualstatement process. Consensus on the topic had notbeen reached by the time of the Fall NationalMeeting, at which the working group asked theindustry to support its efforts to finalize theinformation that regulators should collect oncorporate governance, and to defer discussion onhow the information should be protected until later.

The need for the regulatory approach to corporategovernance to allow for proportionality andflexibility was also discussed extensively, particularlyin relation to the proposed exhibit E. Industryrepresentatives noted that corporate governancepractices vary between individual insurers, and thata one-size-fits-all approach would not beappropriate. While not disagreeing with this,working group members were supportive of greaterstructure around corporate governance regulation.In discussions, the working group viewed itsproposals, in conjunction with the new ORSA andForm F filings, as a significant upgrade to theregulation of corporate governance issues, whichwould create greater discipline through the annualfiling process, and provide necessary information inbetween periodic examinations. Working group




members also considered that the proposals wouldbenefit industry, by aligning regulation more withcompanies’ own view of their risks and internalmanagement.

Throughout the discussions, the working grouprecognized the need to avoid duplication in theinformation requested, and welcomed input frominterested parties on where information consistentwith the proposed exhibits is already collected.Language was also added into Exhibit A to allowinsurers to reference information already containedin other documents available to the regulator. Theneed for more training and guidance for examinersand analysts was also raised by both industry and theworking group.

The proposed exhibits are available for publiccomment until January 18, 2013.

International Solvency andAccounting Standards WorkingGroup

The working group met at the Fall National Meetingin National Harbor, and discussed the followingtopics:

Insurance contracts projectThe working group heard that the IASB expects toissue a targeted exposure draft of its replacement forIFRS 4 in the first half of 2013. The exposure draft isexpected to include the entire standard, but willcontain targeted questions, rather than invitingcomments on the whole text. Areas of focus for theexposure draft are expected to include:

Treatment of unearned profit. Treatment of participating contracts. Presentation of premiums, claims and expenses

in the statement of comprehensive income. Presentation of the effect of changes in the

discount rate in OCI. Retrospective application if practicable. Estimated residual margin on transition if

retrospective application is impracticable.The IASB currently intends to publish a finalstandard by the end of 2014. However, the workinggroup heard that this timeline is optimistic, and thatpublication in 2014 may therefore be unlikely. TheIASB expects the standard to be effectiveapproximately 3 years after publication.

Financial instruments projectThe working group heard that the IASB has justpublished a new exposure draft of limited changes tothe IFRS 9 classification and measurementrequirements. The amendments propose theintroduction of a fair value through OCI category forfinancial instruments, and the working group heardthat almost all insurers would be likely to meet therequirements to use this category. The exposuredraft is available for comment until March 28, 2013,and the NAIC intends to provide comments.

Other IAIS activitiesThe working group heard that the IAIS Accountingand Auditing Issues Subcommittee is drafting anissues paper on supervisors’ expectations of externalauditors, and may consider drafting a new ICP onthe topic over the coming year.

International InsuranceRelations Committee

The committee met several times by conference callover the late summer and fall, and then held an in-person meeting at the Fall National Meeting inNational Harbor and discussed the following topics.

Financial Stability Committee and GlobalSystemically Important Insurers (G-SIIs)The committee discussed the IAIS’s FinancialStability Committee both by conference call in earlyNovember, and at the Fall National Meeting. Thecommittee heard that the FSC completed a seconddata call from around 50 insurers in October, andthat its analysts are now working through the dataproduced. A subset of companies has been identifiedand will now be investigated further by the FSC’sanalysts, working with national supervisors. It ispossible that another data call will be required.These further investigations are expected to becompleted in February, with recommendations onwhich insurers, if any, should be designated G-SIIsmade in March. The names of any insurersdesignated G-SIIs are expected to be finalized andmade public in April, in consultation with theinsurers’ national supervisors.

The committee further heard that the IAIS released apublic consultation on the proposed policy measuresto be applied to G-SIIs in October, with commentsdue by December 16. The paper recommends thatpolicy measures be applied to G-SIIs in 3 areas:

Enhanced supervision – supervision shouldcover the whole group, and in particular should




take into account non-traditional and non-insurance (NTNI) activities. G-SIIs should workwith their supervisors to produce a SystemicRisk Reduction Plan, which may includeseparation of or prohibition from undertakingNTNI activities.

Effective resolution – G-SIIs should be requiredto establish Crisis Management Groups, developRecovery and Resolution Plans, conductresolvability assessments, and adopt cross-border cooperation agreements.

High Loss Absorption (HLA) – G-SIIs shouldhave higher HLA capacity, applied first to NTNIactivities if effectively separated, and then at thewhole group level. The paper notes that HLA atthe whole group level may not necessarily beneeded after NTNI measures have been applied.

Following the National Meeting, the committee metby conference call to discuss the NAIC’s draftcomments on the consultation paper. Consistentwith the NAIC’s previous position on the measures,the comments support the separation and/orrestriction of NTNI activities, and recommends thatthe measures be targeted to those activities that areconsidered to cause systemic risk. The commentsalso recommend that group-wide HLA should not beconsidered mandatory, and/or should only beapplied after all other measures. The commentssuggest that mandatory group-wide HLA and/orhigher capital requirements could produceunintended consequences including higher prices forconsumers and reduced competition.

At its meeting in National Harbor, the committeeheard that, following the consultation, revised policymeasures are expected to be presented to the FSC inMarch 2013 and to the G20 in April 2013. The IAIS’sconsultation notes that G-SII measures on enhancedsupervision will begin as soon as the first group of G-SIIs has been designated.

The committee also heard comments and questionsfrom interested parties on the identification processand proposed policy measures. Questions includedthe timeline for decisions on which companies willbe designated G-SIIs, and how data from differentcompanies has been adjusted for comparability.Interested parties also requested the proposed policymeasures to be subject to a second publicconsultation once the criteria and methodology forthe identification of G-SIIs have been concluded.

EU-U.S. Dialogue ProjectThe IIR Committee heard an update on the EU-U.S.Dialogue Project, and the public hearings held inWashington DC and Brussels in October on itsreport comparing certain aspects of the EU and U.S.regulatory regimes. The discussions at the publichearings are summarized under the IAIS 2012Annual Conference, above. The committee heardthat the dialogue project steering committee and itstechnical committees are currently reviewing thecomments received to ensure that the report isfactually accurate, and reflects recent regulatoryregime enhancements. The steering committeeexpects to finalize the report by December 19.

The committee heard that the steering committee isalso considering its next steps and potential areas ofconvergence, and that it may set out a timetable forits activities in 2013 by the end of the year. Inresponse to a request from an interested party forthe discussions to be opened to observers,Commissioner Kevin McCarty, a member of thedialogue project steering committee, confirmed thatdiscussions are likely to be kept closed for now,although greater transparency will be considered asthe project moves forwards.

Joint ForumThe committee received an update on the activitiesof the Joint Forum, including its recent meeting inTokyo, at which longevity risk and the potentiallysignificant impact of forecasting errors arounddemographic trends were a significant topic ofdiscussion. The committee also heard that the JointForum Working Group on Risk Assessment andCapital is near to finalizing its paper on mortgageinsurance, and is also working on a report on pointof sale disclosures for collective investment schemes(for example, mutual funds), including considerationof the variations between schemes and disclosurescross-sector. The working group is also consideringlongevity risk.

The committee further heard that the Joint Forum’sPrinciples for the Supervision of FinancialConglomerates were issued in September 2012, andthat the forum is now considering pilot testing theprinciples. The Joint Forum is expected to ask 2 to 3countries to take place in the pilot.The committee also heard that the forum isconsidering potential future mandates, which it willdiscuss further in February 2013. Potential futureareas of focus include convergence, assetencumbrances (for example, assets pledged ascollateral), compensation best practices, and fit andproper requirements. Finally, the committee heard




that Thomas Schmitz-Lippert of BaFin will replaceDr. Terri Vaughan as the Chair of the Joint Forum.

ComFrameThe International Insurance Relations Committeediscussed ComFrame both on interim conferencecalls, one of which was held jointly in August withthe SMI Task Force, and in National Harbor. InAugust, the committee and the SMI Task Forcediscussed the NAIC’s comments on the IAIS’s 2012consultation on its ComFrame concept paper, inaddition to comments on ICP 9 (Supervisory Reviewand Reporting) and the IAIS’s Application Paper onRegulation and Supervision supporting InclusiveInsurance Markets. The final draft commentsdiscussed by the committee were consistent withthose discussed at the Summer National Meeting inAtlanta, and were represented by the NAIC at theIAIS’s 2012 Annual Conference in Washington DC inOctober, as described further in the summary of theAnnual Conference above.

In National Harbor, the committee discussed severalsignificant recent developments to ComFrame, i.e.that it is now generally recognized at the IAIS asbeing too long, too prescriptive, and too detailed incertain areas. The committee heard that the IAISTechnical Committee has approved the restructuringof ComFrame. Further, the expansion andinterpretation of the ICPs in the 2012 concept paperis now to be removed, and material from the ICPsquoted in ComFrame verbatim. Changes will also bemade to clarify conflicting terminology.

One of the most significant changes is ComFrame’sapproach to the assessment of group capital. Muchdiscussion at the IAIS’s 2012 Annual Conferencesurrounded whether ComFrame should be used tocreate a top-down, global capital standard for IAIGs.The NAIC argued strongly against this objective atthe Annual Conference, and in National Harborreported that the IAIS is now expecting to use ascenario-based approach to group capitalassessment. Using this approach, IAIGs are expectedto assess capital adequacy in the context of a set ofagreed scenarios, which may be prescribed for allIAIGs, set within prescribed boundaries by nationalsupervisors, or a combination of the two methods.

ComFrame was also discussed in National Harbor bythe International Solvency and AccountingStandards Working Group. The working group heardthat the IAIS Technical Committee, at the suggestionof the NAIC and others, had now agreed to changeComFrame’s valuation standard to recognize otheraccounting frameworks, and that IFRS or any

equivalent set of accounting standards could now beused, including specifically U.S. GAAP or JapaneseGAAP. However, recognizing the differencesbetween these frameworks, and also the differencesthat remain in the valuation of insurance contractsbetween different countries that have adopted IFRS,in the absence of a single standard for insurancecontracts, the IAIS Accounting and Auditing IssuesSubcommittee (AAISC) intends to requireadjustments to narrow, but not attempt to eliminate,the differences between different GAAP figures.

In order to reach the required adjustments, theAAISC intends to carry out a study into the valuationof insurance contracts under each key GAAP, inaddition to making use of previous work onprudential filters. The study is expected to involvevaluing a representative sample of insurancecontracts under each GAAP, in order to help quantifythe differences in valuation. The working groupheard that the AAISC has called on industry, ratingagencies and professional accounting firms tosupport the study with any available data or existingwork.

The IAIS expects to carry out a field testing exercisefor ComFrame in 2013, and a field testing task forceis expected to be established in early 2013. Thescenario-based approach to group capitalassessment is expected to be tested, in addition totesting on the scope of the group. Notwithstandingthe decision to move forward with the scenario-based approach, a top-down approach to groupcapital is also expected to be tested.

At its meeting in National Harbor, several NAICcommittees and working groups heard commentsfrom interested parties on ComFrame, who overallwelcomed the new direction for the project, andrecognized the NAIC’s role in shaping this at theIAIS. Industry concerns discussed at the FallNational Meeting included the potential for theframework to create an un-level playing field forinternational groups, the need for an appeals processfor the designation of a group as an IAIG, and theneed for the reduced level of prescription to beapplied throughout the draft. Interested parties alsoraised the need for clear objectives for theComFrame project, and asked whether solvencyassessments carried out under ComFrame will bepublic information, the purpose of the solvencyassessment, where any additional capital requiredshould be held (for example, at holding companylevel), and how the Prescribed Capital Requirement(PCR) should be calculated. With respect to potentialrequirements for groups to hold additional capital,




the International Solvency and AccountingStandards Group heard that it is not envisaged thatComFrame would prescribe where additional capitalshould be held, but that this would be decided by therelevant IAIG’s college of supervisors on a case-by-case basis, and indeed that the college may decidethat de-risking would be more appropriate thanholding additional capital.

Comments were also heard on whether ComFramehas the potential to apply the measures designed tobe applied to G-SIIs to all IAIGs. In general, theNAIC concurred with industry concerns expressed atthe National Meeting, including the need for a levelplaying field. However, the NAIC confirmed thatthere is no intention for ComFrame to incorporatemeasures for G-SIIs. This was confirmed by GeorgeBrady, Deputy Secretary General of the IAIS, whowas also in attendance at the meeting on theinvitation of the NAIC.

Further revisions to ComFrame are expected to bemade in December, followed by review, discussionand possibly additional drafting in early 2013. Thefindings of the field testing, which will proceedconcurrently, are expected to influence the drafting.By the end of May 2013, ComFrame is expected toenter a final “fatal flaw and fine-tuning” stage.

International RegulatoryCooperation Working Group

The working group met in National Harbor, anddiscussed various topics relating to the NAIC’sengagement with overseas regulators. The workinggroup heard that Washington recently became thesecond U.S. state to sign the IAIS’s MultilateralMemorandum of Understanding (MMoU), and thata third U.S. signatory is expected before the end of2012. Discussions at the International InsuranceRelations Committee meeting at National Harborfurther indicated that MMoU signatories now coveraround 50% of global insurance premium, and thatanother 4 to 5 U.S. states are close to applying formembership. The International RegulatoryCooperation Working Group members wereencouraged to enter the assessment process for theMMoU, although the working group also discussedthe benefit of the time required to complete theassessment process, compared to entering intoseparate confidentiality agreements for individualsupervisory colleges.

The working group also heard an update on theIAIS’s Implementation Committee’s projects,

including the Standards Observance Subcommittee’sself-assessment and peer review program. Theworking group heard that reviews against ICPs 1, 2,and 23 (supervisory objectives, powers, andresponsibilities, and group supervision) are nearlycomplete. A report making recommendations forimprovement to the ICPs following the review is dueto be drafted and issued next year. Reviews of ICPs4, 5, 7, and 8 (governance, risk management andinternal controls) are scheduled to take place nextyear, with estimated completion by October 2013.

The working group also recommended to theInternational Insurance Relations Committee thatthe NAIC enter into negotiations to establishMemoranda of Understanding (MoUs) with theUAE, India and Nigeria, in order to furtherregulatory cooperation between the NAIC and thoseterritories. The request was later approved by theInternational Insurance Relations Committee, at itsmeeting at National Harbor.

Valuation of Securities TaskForce

2012 Year-End RMBS & CMBS ModelingThe task force held three conference calls in Octoberto discuss macroeconomic assumptions, scenariosand risk-weightings for the 2012 year-end financialmodeling of RMBS and CMBS investments. The taskforce noted that since the modeling approach began,the SVO staff has been instructed to take a relatively“neutral bias” when recommending the assumptionsfor the year-end modeling effort. For the 2012 year-end modeling, the SVO staff proposed a shift to whatthe task force chair termed a “slightly moreconservative bias.” Industry representatives,including ACLI, expressed many concerns with theassumptions recommended by the SVO, includingthat they were too pessimistic and would have asignificant impact on required capital levels.

Given the concerns raised by both task forcemembers and industry representatives, the taskforce agreed to extend its consideration of the SVOrecommendations for an additional two weeks. TheSVO staff responded to concerns in a Q&A documentand concluded that there was no basis upon which tomodify the original recommendations. Based on thecomposition of the 2011 industry-wide RMBSportfolio holdings and price points, the SVOestimated that the aggregate capital charge wouldincrease from 2.7% to 3.2% of the book/adjustedcarrying value. The impact on the 2005-2007 RMBSvintage would go from 3.3% to 4.2%. The impact was




estimated to be much smaller for CMBS. The SVOfurther estimated the industry-wide capitalrequirements for the life insurers would increase byapproximately $700 million under the worst-casescenario, while the increase for P&C insurers wouldbe closer to $50 million.

Following significant discussion and debate, the taskforce adopted the SVO recommendations on theOctober 26 conference call. Iowa and Oklahomavoted against the recommendations and Kansasabstained. Task force members acknowledged thatthe process and timeline for developing andapproving modeling assumptions must be criticallyreviewed before the 2013 year-end process begins.

At the Fall National Meeting the SVO reported thatthe RMBS and CMBS financial modeling process waswell underway and expected to be completed beforeyear-end.

Preferred Stock Exchange Traded Fund CategoryOn its September conference call the task force alsoadopted the previously exposed proposal to amendthe SVO Purposes and Procedures Manual to add anExchange Traded Fund (ETF) category for preferredstock in addition to the existing bond ETF category.

Quarterly Reporting of Modeled SecuritiesIn National Harbor, the task force discussedproposed guidance for quarterly reporting ofmodeled RMBS and CMBS, and instructed the SVOto use it as a basis to develop edits to the SVOPurposes and Procedures Manual. The task forcebelieves that insurance companies should reportinterim purchases of RMBS and CMBS that aresubject to financial modeling as follows:

If purchasing a modeled RMBS or CMBS wherelast year’s modeling data are available, use lastyear’s modeling data to determine thedesignation and book/adjusted carrying value;

If purchasing a modeled RMBS or CMBS wherelast year’s modeling data are not available, usethe modified filing-exempt process to determinethe designation and book/adjusted carryingvalue.

A formal proposal is expected to be exposed forpublic comment on a future task force conferencecall.

Working Capital Finance InvestmentsDuring a September 6 conference call, the task forceunanimously adopted the previously exposed,proposed statutory accounting framework for

Working Capital Finance Investments (WCFI)developed by New York. The final proposal wasreferred to the Statutory Accounting PrinciplesWorking Group and related proposals to the BlanksWorking Group and the Capital Adequacy TaskForce. The proposal recommends that WCFI beadmitted asset. The referral by the task force alsoincluded two additional recommendations: (1) WCFIshould be reported on Schedule BA and (2) underthe corporate methodology developed by the SVO,WCFI should be assigned either NAIC 1 or NAIC 2designations based on the credit risk associated withthe corporate obligor.

Local GAAP Financial StatementsThe task force discussed a previously exposed ACLIproposal to allow the SVO to accept audited financialstatements of foreign issuers expressed inaccordance with a national generally acceptedaccounting principles (GAAP) or nationalInternational Financial Reporting Standards (IFRS),instead of just accepting audited financial statementsexpressed in, or reconciled to, U.S. GAAP or officialIFRS. The task force directed the SVO to work withACLI representatives to evaluate whether there areinformational resources that would permit the SVOto use financial information presented on a nationalGAAP or national IFRS basis to conduct creditanalysis comparable to that performed usingfinancial information presented on the basis of U.S.GAAP or official IFRS.

NAIC Designation Recalibration ProjectThe SVO discussed proposed definitions for NAICdesignation categories under the proposedrecalibration project. As currently proposed, theNAIC would transition from the current single NAICrating designation framework (1-6) to three separateframeworks: one each for corporate bonds,municipal bonds and asset-backed securities. Theproposal would create new NAIC designationsymbols and definitions. Additionally, RBC factorswould be updated based on the work of the C-1Factor Review Subgroup. The task force instructedthe SVO to work with the ACLI and other interestedpersons to develop agreed-upon definitions and topresent a joint recommendation to the task force forits consideration.

Mandatory Convertible SecuritiesThe task force discussed the current regulatoryframework for mandatory convertible securities andwhether current instructions to the SVO on thisissue, which expire January 1, 2013, should becontinued, either in the SVO Purposes andProcedures Manual or in statutory accountingguidance. NAIC staff was asked to consider valuation




and definitional issues and to providerecommendations on an expedited basis to ensureinstructions are in place by January 1, 2013.

Reinsurance Task Force

The task force met at the Fall National Meeting inNational Harbor, and discussed the following topics.

Reinsurance Modernization ImplementationThe task force heard an update on the adoption ofthe revised credit for reinsurance models by thestates. The revised models have been adopted byCalifornia, Connecticut, Delaware, Florida, Georgia,Indiana, Louisiana, New Jersey, New York,Pennsylvania and Virginia. Eleven additional statesindicated that they intend to adopt the revisions,with 26 undecided. The task force heard that Floridaand New York had so far approved 19 and 23reinsurers, respectively, for collateral reductions asof November 28.

The task force also heard an update from thedrafting group of the Reinsurance Financial AnalysisWorking Group. The drafting group had finalized adraft of a procedures manual for the working groupon November 19, which has been presented to theReinsurance Task Force. The update provided at theFall National Meeting indicated that reinsurancecollateral reduction applications should initially besubmitted to a single state, and that review prioritywill be given initially to those reinsurers that wereapproved by states before the adoption of theworking group’s procedures.

The task force also discussed a draft of the NAICProcess for Developing and Maintaining the List ofQualified Jurisdictions, prepared by the QualifiedJurisdiction Drafting Group in collaboration with theFIO and federal authorities. The task force heardthat the proposed process is intended to be anoutcomes-based comparison, which considersadherence to international guidelines, rather than aprescriptive comparison to the reinsurance models.The draft document includes an evaluationmethodology, which considers 8 key topics coveringthe industry, regulatory framework and measuresapplicable to U.S. reinsurers operating in theoverseas jurisdiction concerned. Interested partiescommenting in National Harbor encouraged theNAIC to make full use of reviews carried out forother purposes when assessing overseasjurisdictions, and to consider expediting theassessment of some key jurisdictions. The draftprocess notes that initial priority will be given to

Bermuda, Germany, Switzerland and the UK, each ofwhich has already been approved by Florida and/orNew York.

The task force agreed to expose the draft process forpublic comment until January 16, 2013, and intendsto hold an interim meeting to discuss the commentsreceived. The drafting group noted its intention tofinalize the process document by the Spring NationalMeeting.

Reinsurance Modernization AccreditationThe task force heard that the Financial RegulationStandards and Accreditation Committee hadadopted the 2011 revisions to the Credit forReinsurance Model Law (#785) and Credit forReinsurance Model Regulation (#786), and thesignificant elements proposed by the task force, at itsmeeting in National Harbor. The revisions areeffective immediately. States are not required toadopt the revisions, but if they choose to introducereduced reinsurance collateral requirements, theymust be substantially similar to the key elements ofthe models.

Nonadmitted and Reinsurance Reform Act (NRRA)SurveyThe task force discussed a survey of the states that ithad conducted into issues with respect to the NRRA,and whether the NAIC should develop a standarddefinition or guideline to help promote consistencyin its application. The task force agreed to discussthe results of the survey further at a future meeting.

International Reinsurance IssuesThe task force discussed the EU-U.S. dialogueproject (discussed further under the InternationalInsurance Relations Committee, above), noting thatreinsurance is likely to be an ongoing focus fordiscussions. The task force also received an updateon IAIS discussions relating to reinsurance,including the Global Insurance Market Report,released in October 2012, which builds on the formerGlobal Reinsurance Market Report, ComFrame, thestability of the reinsurance market, and captiveinsurers.

The task force also received a presentation from theIAIS on a study carried out into the impact ofinsurance/reinsurance following major naturalcatastrophes. The study found that sufficientinsurance/reinsurance coverage can reduce thenegative effect on economic growth that it considerswould usually follow a major catastrophe, and thatsufficient coverage of catastrophe losses can in factlead to a positive growth effect overall.




Captive and Special PurposeVehicle Use Subgroup

The subgroup held a conference call October 17, thegoal of which was to discuss the latest draft of itsCaptives and Special Purpose Vehicles White Paper,before exposing it for comment. Significantrevisions from the draft discussed at the SummerNational Meeting are as follows:

Confidentiality – The subgroup could not reach aconsensus view so delineated both views and willlikely ask its parent E Committee to decide.Some subgroup members support continuing toallow confidential treatment of captivetransactions and financial statements whileothers support more transparency and publicdisclosures.

Additional discussion on credit for reinsuranceand accredited reinsurance was added.

Captive database – The October 17 draft includesa suggestion that consideration be given todeveloping a database including NAIC companycode, name, and domiciliary information withrespect to all captives “to ensure that data on theuniverse of all such entities is available to allowregulators to quickly respond to questions on thesame.”

Conclusions – the subgroup tried to providemore clarity around the recommendationsincluding a proposal to form a new group to“develop possible solutions for addressing theremaining XXX and AXXX perceivedredundancies.” The recommendations alsoinclude the following statement: “The Subgroupheld a consensus view that captives and specialpurpose vehicles should not be used bycommercial insurers to avoid statutoryaccounting prescribed by states. If the liabilitiesare retained by the insurer, they should not begranted favorable treatment merely for carryingthe liabilities on the books of an affiliate ratherthan directly.”

The subgroup then voted to expose the white paperfor public comment.

At its meeting in National Harbor, the subgroup helda public hearing to discuss comments on the draftwhite paper; two states commented (Nebraska andVermont), along with six trade associations and onelarge life insurance company. The debate was verycontentious at times, including comments amongregulators. It also included significant discussion of

whether the white paper is “an attack on the captiveindustry.”

As a result of comments received, the subgroupagreed to clarify certain statements in the whitepaper, including modification or removal of thediscussion of the captive industry as a “shadowbanking system.” The regulators also agreed toclarify that they will not be recommending that IAISstandards be adopted; those standards do notrecognize as captives insurance entities that assumethird party risk. The chair commented that theprimary point is that “captives owned by commercialinsurers should not be utilized to engage in activities,or receive treatment for commercial business, that isnot allowed by commercial insurers.” However, thesubgroup member from Missouri stated that hebelieves the white paper should state that the vastmajority of XXX and AXXX transactions have beenthrough a diligent review process includingconsideration of the plan of operations and anactuarial review of reserves.

The suggestion to develop a database for all captivesincluding pure captives was especially contentiousand elicited comments from interested parties whopreviously had not been actively commenting. Thisproposal seems to have less support from thesubgroup members than some of the otherrecommendations.

During the meeting, the chair of the subgroup’sparent committee, Commissioner Torti of RI, statedthat he was “deeply disappointed” with the overallcomments. He views the issues underlying the whitepaper as life insurance reserving issues and not acaptive issue. Commissioner Torti also indicated hisconcerns about the use of permitted practices bycaptives, which he believes are intended to be usedonly for “narrowly defined issues or circumstances.”He also stated that with respect to confidentiality,states’ laws generally require that all information bepublic unless it is specifically deemed confidential,whereas comments received on the white paper“suggest just the opposite.”

Other than rectifying some “misunderstandings” inthe white paper, eg the “shadow industry” comment,it is not clear what other revisions will be made tothe white paper. A revised draft was expected to bedistributed shortly after the Fall National Meeting,but nothing has been issued as of the publication ofthis Newsletter. Another public hearing is alsoexpected to be held prior to finalizing the whitepaper.




NAIC/AICPA Working Group

The working group held a conference call on October23 and discussed the following topics:

MAR Implementation GuideThe working group adopted a proposed addition tothe MAR Implementation Guide to provide guidanceand a sample report for situations where a holdingcompany or parent insurance company not subjectto Section 404 wishes to submit a groupManagement’s Report of Internal Control overFinancial Reporting for companies within theirholding company system that are subject toManagement’s Report of Internal Control overFinancial Reporting filing requirements.

Restricted AssetsIn response to a referral from the Financial AnalysisWorking Group related to solvency concerns ofmaterial amounts of restricted assets at someinsurers, the working group asked the AICPArepresentatives for assistance in determiningwhether generally accepted auditing standardsrequire bank confirmations of restricted/pledgedassets and what specific disclosures are required inaudited financial statements. During the Octoberconference call, a representative of the AICPAreported that under GAAS, audit confirmations areperformed as a result of risk-assessment proceduresand would not necessarily be performed on all assetsheld by the insurer. However, for those assets thatare confirmed during an audit, the standardconfirmation form asks whether any assets arepledged as collateral or otherwise encumbered. Inaddition, the sample representation letters providedin the AICPA insurance guides includerepresentations by management on restricted assets.

The chair asked the AICPA to consider highlightingthe importance of a review for restricted assets in itsinsurance audit guides and Audit Risk Alerts in lightof the problems that have been identified, which theAICPA agreed to consider. The working group alsoadopted that a recommendation be sent to theFinancial Examiners Handbook Technical Group toconsider guidance for examiners in reviewing forasset restrictions. One regulator suggested that abetter way to address problems related to assetrestrictions might be for the states to pursue an assetprotection act, similar to those in place in Virginiaand Texas, which would require an insurer to getinsurance department approval before pledginginsurance company assets. That suggestion wasreferred to the Financial Analysis Working Group.

Blanks Working Group

The working group exposed 10 new blanks proposalsfor a public comment period which ends March 7,2013. These proposals will be considered foradoption on a conference call to be scheduled inJune. The proposals would:

Add a requirement to the Annual AuditedFinancial Reports for auditors to include testingof underlying data provided to the actuary forestimating reserves to the statutory auditprocess for title insurance. This requirementwould be similar to the current requirement forP&C insurance. (2012-31BWG)

Add instructions to the Property and CasualtyLine of Business Appendix to indicate that thewrite-ins line should include all types of businessthat are placed by a lender (“force-placed orlender placed”). For all force-placed business, aseparate line should be used for each annualstatement line of business that is written by thereporting entity. (2012-33BWG)

Separate the State Low Income Housing TaxCredit (LIHTC) categories on Schedule BA intoguaranteed and nonguaranteed similar to theFederal LIHTC. (2012-34BWG)

Modify the illustration for Note 17C to allow fordisclosure of unrated securities and securitiesother than bonds and preferred stocks. (2012-35BWG)

Add a new line and modify instructions forcertified reinsurers to page 3 of the TrusteedSurplus Statement. (2012-36BWG)

Add instructions and an illustration to Note 22,Events Subsequent, to disclose assessmentsunder the Affordable Care Act not beingrecognized in the financial statements. (2012-37BWG)

Add category lines to Schedule BA for WorkingCapital Finance Investments and a descriptionfor those lines in the annual and quarterlystatement instructions. (2012-38BWG)

Modify various parts of Schedule F (property)and Schedule S, (life, health and fraternal)moving bank information for letters of credit tothe footnote table. (2012-39BWG)




Add information about Certified ReinsurerIdentification Number (CRIN) to be consistentwith the information provided in the generalinstructions for Schedule F and S in the annualstatement instructions regarding federal IDnumber. The proposal would also addinstructions for the column on how to indicatethe type of reinsurer. New columns withdescription “Certified Reinsurer Rating (1through 6)” and “Effective Date of CertifiedReinsurer Rating” would be added to Schedule Fand S. (2012-40BWG)

All Blanks proposals, including those adopted andexposed for comment, can be viewed at the BlanksWorking Group page on the NAIC’s website.

Life Actuarial Task Force

PBR Valuation ManualVM-20 Asset Default MethodologyLATF received a report from the Academy which wasessentially a refresher of the current methodology inVM-20 to determine asset defaults. The currentmethodology has 3 components: a baseline annualdefault cost factor, a spread related factor and amaximum net spread adjustment factor.Subsequently, regulators from NY listed severalissues with the current methodology followed by anACLI presentation on the subject. Conference callswill be scheduled to discuss.

Aggregate MarginsLATF formed a subgroup at their last meeting toconsider an aggregate margin approach forquantifying uncertainty versus the current granularlevel of assessing margin in VM-20. The LATFsubgroup is working with an Academy group whichhas reported significant progress. No specifics werepresented at this meeting.

Post Level Term Profit RestrictionsDuring an interim call, LATF unanimously adopted aproposal to limit term life policy profits that acompany can recognize by adjusting its modelingassumptions under VM-20 for periods for whichcredibility and relevance is low; generally this occursbeyond the level premium paying period.

VM-20 MortalityLATF adopted during an interim call a proposal tochange the mortality table in Section 9(Assumptions) of VM-20 used to grade fromcompany experience to industry experience. Theamendment requires using a table with more

stringent credibility requirements for valuations onor after January 1, 2015.

VM-20 Economic ScenariosLATF adopted a proposal that clarifies that theValuation Manual does not specify a requirednumber of scenarios. The change also clarifies howthe economic scenario generator is to be used for thepurposes of calculating deterministic and stochasticreserves, defines the mean reversion parameter andprovides the website location at which the economicscenario generator can be accessed. The ACLIsuggested that LATF continue to study the impact ofthe scenario generator and mean reversion rate. TheACLI will continue to do testing related to thereserve volatility.

Blanks IssuesLATF voted to expose for comment a draft documentfrom 2008 that described potential changes to theannual statement blank to reflect PBR. Itemsincluded on the list of changes are Page 3(Liabilities), Page 7 (Analysis of Increase inReserves), Exhibit 5 (Reserves), Exhibit 5A (Changesin Valuation Bases) and a new Exhibit 5B (PBRReserves). Regulators questioned theappropriateness of including changes in PBRreserves due to changes in PBR assumptions inExhibit 5A. During this discussion, LATF wasreceptive to a verbal ACLI proposal to allow anadditional 2 year grade-in period for smallcompanies to implement PBR so that smallcompanies are not competing for consultingresources during a time when these resources arelikely to be scarce.

Other ItemsDuring an interim call, LATF also adopted VM-20changes to the mortality credibility percentages,starting asset requirements, and the allocation of thestochastic and deterministic reserves to individualpolicies using the net premium reserves as the basis.

Actuarial Guideline XXXIII (AG 33)Guaranteed Living Income BenefitsLATF continued its discussion on issues related tothe application of AG 33 to Guaranteed LivingIncome Benefits (GLIB) attached to fixed (non-variable) annuities. Regulators conceded that thecurrent application of AG 33 for these benefits likelyoverstates reserves under AG 33’s underlyingprinciple that all policyholder behavior will beoptimal, resulting in the highest possible reserve.LATF discussed 3 options available to the task force;(1) do nothing, thereby continuing with the currentAG 33 redundant reserve requirements, (2) modify




AG 33 to allow election rates for these benefits to beless than 100% in the reserve calculation, or (3)modify AG 43 to cover these benefits since they aresimilar to GLIBs offered under variable annuities.After a lengthy discussion, the regulators rejectedoption 1, and then subsequently rejected option 3which was quickly followed by the rejection of option2. The LATF chair stated: “We have no directionright now.” LATF opted to schedule a call to discussfurther.

Reserves for Participating Income AnnuitiesLATF received a proposal from NorthwesternMutual to increase the reserve requirements for anew product design for participating incomeannuities with low minimum guarantees but with asignificant portion of future benefits expected tocome from non-guaranteed dividends on thecontracts. The proposal, driven by a tax reserveissue, proposed a change in AG 33 for participatingpolicies only that would increase the statutoryreserve requirements (and would lead to higher taxreserves). Although LATF voted to expose theproposed revision to AG 33, there was considerabledoubt among regulators that it is appropriate to havedifferent reserve requirements for participating andnon-participating policies.

C-3 Phase 2/AG 43 SubgroupThis subgroup of both A and E Committees ischarged with developing more consistency betweenRBC’s C-3 Phase 2 and AG 43 reserves. Short termaction items, which include the definition of “in themoney,” issue year discount rates and standardscenario lapse rates, are expected to be completed byyear end 2013. There was no specific timetable forlonger term action items.

Nonforfeiture ModernizationLATF received a “mini report” from the Academy’sNonforfeiture Modernization Working Group. TheAcademy has developed a methodology fordetermining the Guaranteed Nonforfeiture Basisused to calculate the Required Policy NonforfeitureAccount. This is a retrospective approach predicatedon the policy owner's prefunding of benefits throughpremiums paid and interest credited in excess ofamounts required to pay benefit and expensecharges to date. The Academy provided examples ofhow the methodology would work for common typesof life insurance. The Academy is looking forsignificant guidance from LATF regardingassumptions and regulatory and actuarial guardrailsfor those assumptions. In the meantime, theAcademy is developing additional examples for more

complex products and developing a position on acash value option for nonforfeiture.

Generally Recognized Expense Table FactorsLATF adopted the 2013 GRET factors during aninterim call. These factors had previously beenpresented by the SOA Committee on Life InsuranceCompany Expenses. These factors vary bydistribution channel, consistent with the currentfactors, and reflect reductions in the General Agencyand Brokerage factors and increases in factors forother distribution channels.

Payout Annuity Mortality TablesPrior to the Fall National Meeting, LATF adoptedNAIC Model Regulation #821 for Recognizing a NewAnnuity Mortality Table for Use in DeterminingReserve Liabilities for Annuities. The effective dateof the table will be January 1, 2014. The model wasadopted by the NAIC at the Executive and Plenarysession in Washington.

Synthetic GIC ReservesLATF received a recommendation from the Academyto modify the reserve requirements for syntheticGICs. Currently there is a mismatch between assetand liability valuations with these products whichcreates unnecessary volatility in statutory financialresults. The Academy’s proposal suggested changingthe valuation discount rate to a 50/50 blend ofTreasury spot rates and a corporate bond index, andto eliminate the AVR factor-based deduction in thereserve in cases where the default risk is borne bythe policyholder. LATF asked the Academy to markup the current Model Law A-695 (SyntheticGuaranteed Investment Contracts). A conferencecall will be scheduled to discuss.

Experience ReportingLATF received an update from the MedicalInformation Bureau proposing a new simplifiedpolicyholder behavior format for experience datagathering. LATF voted to expose this new format forcomments until the end of January 2013.

Joint Qualified Actuary SubgroupLATF (and subsequently HATF and the CasualtyActuarial and Statistical Task Force) agreed to forma Joint Qualified Actuary Subgroup (A/B/C) todevelop recommendations on (1) a uniformdefinition of “qualified actuary” for life, health andP&C Appointed Actuaries signing prescribedStatements of Actuarial Opinion, identifying anydifferences that should remain between lines ofbusiness and a uniform definition of “qualifiedactuary” for other regulatory areas (e.g. rate filings,




hearings), and (2) a definition of inappropriate orunprofessional actuarial work and a process forregulatory and/or professional organizations’actions.

Emerging Actuarial IssuesWorking Group

The Emerging Actuarial Issues Working Group wasformed by the NAIC to address implementationissues resulting from the revision to AG 38 foruniversal life products with secondary guarantees.Prior to Fall National Meeting, the working grouphad exposed for comment 18 interpretations fromquestions received on the new guidance, which wereadopted at the Fall National Meeting. During thisbrief meeting, the working group reviewed newinterpretations. A conference call will be scheduledfor further discussion of these issues.

Health Insurance and ManagedCare Committee

At its meeting in National Harbor, the committeeheard an update from representatives of the federalCenter for Consumer Information and InsuranceOversight (CCIIO) on the Affordable Care Actimplementation activities. The CCIIO update wasfocused on the status of the creation of AffordableInsurance Exchanges, state-based marketplaceswhich launch in 2014 to provide consumers andsmall businesses with "one-stop shopping" foraffordable coverage. In an effort to continue toencourage states to establish exchanges, CCIIO hasextended the December 14 application deadline forstates to apply for Exchange Establishment Fundingfrom December 28. A federally-facilitated exchangewill operate in states that have chosen not to buildtheir own exchange. The exchanges will launch openenrollment in October 2013. With the advancementof the go-live date, the CCIIO has a few projectsunderway such as issuing a system application,building the website and 24-hour call center, andsetting up plan valuation tools. Concerns regardingtiming were raised during the meeting, as it relatesto product filings and plan review. Additionally, thecommittee members raised concern over potentialrate shock for young individuals resulting from the3:1 age-band requirement. The concerns stem fromthe possibility that with an age band as narrow as3:1, premiums for younger people will be brought upconsiderably higher in order to compensate for olderindividuals, who typically utilize more health careservices yet can only have premiums that, at most,

are three times higher than those for youngerindividuals, who typically are light users of service.

The committee chair commented that it is a validconcern that younger folks facing a weak penalty willstay out of the market until those penalties haveincreased to a point where it makes sense to buycoverage. The chair suggested that the 3:1 age bandstart with a broader range (5:1) and then be broughtdown gradually over a period of several years, tominimize rate shock. While admitting that thestatute in the reform law is clear about the 3:1 ageband, CCIIO indicated that comments on policyimplications are welcomed and will be taken intoconsideration for implementation of the 3:1 band.

Health Actuarial Task Force

Long Term CareThe LTC Actuarial Working Group received apresentation from Genworth which provided anoverview of LTC product pricing. In an interestingcomparison of “general” LTC pricing assumptionsbetween pre-2000 issues and current new business,the report noted that ultimate lapse rates have gonefrom 5.5% to 1%, interest from 7.5% to 4% andmortality assumptions are lower partly due to thecurrent use of mortality improvement factors. Inother matters, the Academy noted that its practicenote, Long-Term Care Insurance Compliance withthe NAIC Long Term Care Insurance ModelRegulation Relating to Rate Stability, has beenreleased and is on the Academy’s website(www.actuary.org). In addition, HATF asked theAcademy for assistance in reviewing theappropriateness of current LTC reserve standards.

Cancer Claim Cost TableThe task force received a report from the jointAcademy & SOA Cancer Claim Cost Table WorkGroup on the development of a new cancermorbidity table. The working group was pleased toreport that 17 companies have responded to the datacall and they are working to validate and synthesizethe data. The working group reported that they hopeto be in a position to present preliminary data at theSpring National Meeting.

Group Long Term DisabilityDuring an interim call, the task force voted to(1) extend the deadline for comment on the proposedvaluation table to May 31, 2013; (2) expose forcomment the proposed revisions to Model #10,Minimum Reserve Standards for Individual andgroup Health Insurance Contracts, until May 31;




(3) expose for comment the proposed actuarialguideline until May 31; and (4) request that theAAA/SOA Group Long-Term Disability Work Groupassist the task force in reviewing comments receivedconcerning the initial valuation table exposure andall future comments related to the proposedvaluation table, revisions to Model #10 and theproposed actuarial guideline.

Individual Disability ExperienceThe task force received a report from the SOA’sIndividual Disability Experience Committeeregarding valuation tables for individual disabilityinsurance. Current experience, both with regard toincidence rates and termination rates, has generallydeteriorated since the current tables were developed(pre-2000). At the end of the presentation, the taskforce requested that the Academy develop a newindividual disability income valuation table based onthe SOA’s current experience analysis.

Contingent Deferred AnnuitiesWorking Group

The working group met August 29 and in NationalHarbor and also held several regulator only calls tocontinue its discussion of the controversial issuessurrounding contingent deferred annuities. Duringthe regulator-only calls the working group developedthree draft recommendations as follows:

1. Recommend to A Committee that CDAs beregulated as variable annuities for the purpose ofmarket regulation and consumer protection.Existing laws that apply to variable annuitiesmay need to be revised to clarify that they alsoapply to CDAs.

2. The adequacy of existing laws and regulationsapplicable to the solvency of annuities, as suchlaws are applied to CDAs, should be referred bythe A Committee to other working groups withappropriate subject matter expertise.

3. A contingent deferred annuity shall be definedas an annuity contract that establishes aninsurer's obligation to make periodic paymentsfor the annuitant's lifetime at the timedesignated investments, which are not owned orheld by the insurer, are depleted to acontractually defined amount due tocontractually permitted withdrawals, marketperformance, fees and/or other expenses.

At its meeting in National Harbor, the workinggroup received extensive comments on the proposed

recommendations, but no conclusions were reached.A representative from the Center for EconomicJustice objected to the fact that there is nodocumentation of the rationale for therecommendations, which were developed in closedmeetings. The chair agreed to have the workinggroup put together a document addressing therationale for the recommendations.

The meeting included a presentation from theInsured Retirement Institute on investmentparameters of CDAs and the related key componentsof an insurer’s asset management evaluation for CDAprotection. The working group also received apresentation from FINRA on its review of CDA salesmaterial for compliance with the content standardsof NASD Rule 2210. Lastly, a representative fromNOLHGA gave a presentation on guaranty fundcoverage of CDAs, in which he concluded that theform of the CDA reviewed by them “appears to beeligible for coverage as annuity certificates issuedunder a group annuity contract.”

Separate Account Risk WorkingGroup

The working group has not met since the SummerNational Meeting, but will hold a conference callJanuary 9 to resume its discussion on insulationclassifications for separate account products.

Financial Regulation Standardsand Accreditation Committee

The committee met in National Harbor and took thefollowing actions:

Revisions to Review Team GuidelinesThe committee adopted revisions to one of thereview team guidelines under the “Communicationof Relevant Information to/from Examination Staff”for financial examinations. The revision was theresult of a referral from the Risk FocusedSurveillance Working Group, and is intended tobring the guideline more in line with the language inthe Financial Condition Examiners Handbookrelated to communications between examiners andanalysts at the conclusion of an examination.

Revisions to Part A PreambleThe committee discussed a proposed revision to thePart A Preamble to clarify that certain accreditationstandards are applicable to health organizations. ThePreamble currently does not make reference tohealth organizations. The change became necessaryas a result of the committees adoption of the Risk-




Based Capital for Health Organizations Model Act asan accreditation standard at the Summer NationalMeeting. The proposal was exposed for a 30-daycomment period.

CPA Audit StandardsThe committee discussed a proposed revision to thePart A CPA Audits accreditation standard to clarifythat state statute or regulation should contain arequirement for annual audits of domestic insurancecompanies “that is substantially similar to” theAnnual Financial Model Regulation. The proposalwas exposed for a 30-day comment period.

Viatical Settlements WorkingGroup

At its meeting in National Harbor, the workinggroup discussed in detail comments received ondrafts of the proposed guideline amendments to theViatical Settlements Model Regulation (#698),including the new Appendix A - InformationalBrochure. The working group agreed to make certainrevisions to the drafts based on comments receivedand discussion during the meeting. On December 7,the working group exposed the revised drafts of theproposed guideline revisions, including a revisedAppendix A. During its December 18 conference call,the working group made minor revisions to thedrafts based on comments received, and adopted therevised drafts, noting that the updated drafts will becirculated to the working group members and theLife Insurance and Annuities Committee. Unless thecommittee requests for the working group toconvene, the working group has completed its chargeand is not expected to reconvene.

Annuity Disclosure WorkingGroup

The working group met to discuss the November 28draft of the Annuity Buyer's Guide for DeferredAnnuities. The draft contemplates a single guide forboth variable and fixed annuity products. Given thebrief period of time between the release of the draftand the meeting, there were no significant commentsmade during the meeting. In working towardfinalizing the Buyer's Guide, the draft was exposedfor comment and conference calls will be held earlyin 2013 to discuss comments received and effectivedate. Comments on the draft were due January 2.

Casualty Actuarial andStatistical Task Force

The task force discussed referrals from the StatutoryAccounting Principles Working Group on theactuarial calculation of death, disability orretirement (DDR) reserve and accounting forpolicyholder loyalty program obligations. The DDRreserve referral pertains to policy reserves related toclaims-made policies that provide extended servicecoverage at no additional charge in the event ofdeath, disability or retirement of an insured person.For these policies, SSAP 65 requires a policy reservefor these contracts (i.e., DDR reserve) to ensure anability to pay future claims arising from thesecoverage features as well as to ensure that thepremiums are not earned prematurely. It has beenidentified that the current guidance in SSAP 65 forcalculating the DDR reserve is inconsistentlyapplied, can be materially impacted by slightchanges in the underlying parameters, and mayhinder application of actuarial methodologiesoutside of the traditional approach. The loyaltyprogram referral pertains to incorporation ofguidance for cash benefit loyalty programs into SSAP65, whereby such cash benefits are treated as part ofpolicy reserves for claims-made policies.

It was discussed at the meeting that an outreach hasbeen made to the SAPWG for additional informationand the task force is awaiting a response. The taskforce also requested input from the AmericanAcademy of Actuaries on both referrals. AAA hasformally responded via comment letter on the DDRreserve matter and provided verbal comments onloyalty program matter. AAA commented that nochange to SSAP 65 is recommended iff the SAPWGdoes not intend to revise the scope, definition, orrepresentation of the DDR reserve obligation andconversely if the SAPWG desires changes in thedefinition or representation of the DDR reserveobligation, additional information to provide furtherperspective on the applicability of different methodsand the financial impact of such a change is needed.AAA agreed with the task force that additionalinformation is needed to consider the loyaltyprogram referral.




Risk-Focused SurveillanceWorking Group

The working group, charged with reviewing theeffectiveness of risk-focused exams andimplementing improvements, met November 16 viaconference calls and exposed two documents forcomment: proposed Critical Risk Categories forReview in Financial Examinations and SoundPractices for Risk-Focused Exams Generated byIndustry Feedback. Interested parties submitted acomment letter January 4 and appear to have somesignificant comments about the documents. Work onthese issues will continue in 2013.

Climate Change and GlobalWarming Working Group

Impact of Climate Exam SubgroupThe subgroup met by conference call on November15 to review proposed updates to the FinancialCondition Examiners Handbook. The subgroupreached consensus on the call and recommended theupdates be considered by the working group. Theworking group approved suggested changes to theFinancial Condition Examiners Handbook via aNovember 19 email vote, and recommended thechanges be considered for adoption by the FinancialExaminers Handbook Technical Group. Thetechnical group met by conference call November20, at which time they adopted the working group’ssuggested updates to the handbook. The revisionsare expected to be included in the next publishedversion of the Examiners Handbook for 2013.

Impact of Climate Disclosure Survey SubgroupThe subgroup plans to resume monthly conferencecalls in the first quarter of 2013 to review the climatedisclosure survey results from the multi-stateinitiative. The subgroup will consider whether thesurvey is meeting its objectives and whether anychanges could be made to improve any aspects of thesurvey.

Title Insurance Task Force

At the Fall National Meeting, the task force receivedan update on projects as follows:

Title Insurance Risk-Based CapitalThe Title RBC Joint Subgroup of the CapitalAdequacy Task Force and the Title Insurance TaskForce held a conference call on November 14 todiscuss the pros and cons of developing risk-based

capital standards for title insurers. In order todetermine if RBC standards are needed for titleinsurers, the subgroup acknowledged that it needs toidentify unique risks of title insurers, examine causesand impacts of insolvencies, and identify challengesin implementing RBC standards for title insurers.The subgroup discussed contacting the FinancialExaminers Handbook Technical Group and theFinancial Analysis Research and DevelopmentWorking Group to understand financial tools thathave been developed for analyzing title insurers. Thesubgroup also discussed contacting domiciled statesof large title insurers to identify prominent riskfactors that title insurers face.

Title Insurance Escrow Theft White PaperSince the Summer National Meeting, the subgroupheld two conference calls to continue its work ondrafting a white paper on escrow theft. It is hopedthat the white paper will serve as a tool for regulatorsto research methods for combating and preventingescrow theft, title insurance theft and other forms offraud associated with title insurance and closingservices transactions. The subgroup has exposedseveral sections of the draft white paper and receivedcomments. The subgroup plans to hold conferencecalls to continue drafting additional sections of thewhite paper.

Title Guaranty FundDuring a conference call held on November 13, theTitle Insurance Guaranty Fund Working Groupdiscussed the guaranty fund research summaryprepared by NAIC staff. The research indicates thefollowing:

There have not been a large number of titleinsolvencies. The data suggests that there weresome problems in 2008 when five titlecompanies were declared insolvent and sincethen, insolvencies have slowed and there doesnot appear to be any single state with asignificant problem.

Although a majority of states have adopted lawssubstantially similar to the Title Insurance AgentModel Act (#230) and the Title Insurers ModelAct (#628), only six states have implemented aguaranty fund or alternative mechanism.

Of the six states that have established guarantyfunds, only two state title guaranty funds havepaid claims for insolvent title companies, whichhave been very small in relation to the title netpremiums earned.




It is doubtful whether a sufficient number ofstates would support the development of a titleguaranty fund model law or guideline. Becausestates regulate title insurance in diverse ways, itis unlikely that a majority of states would agreeon the utility of a guaranty fund or what it wouldcover or how it would be structured.

The working group discussed comment letters fromthe Center for Economic Justice and Old RepublicInsurance Company. Although the Center forEconomic Justice raised strong objections to theNAIC staff research findings and commented thatthere is a serious title insolvency problem, itexpressed opposition to the development of a titleguaranty fund model law or guideline. Old Republiccommented that a guaranty fund is not necessarydue to the presence of the title statutory premiumreserve. The working group agreed that additionalresearch on the impact that insolvency of a majortitle insurance company would have on consumers'needs should be pursued before the working groupcan recommend action.

Risk Retention Group TaskForce

The task force discussed two audit-related concernsraised by NAIC staff regarding the requirements ofthe Annual Financial Reporting Model Regulation(#205) as applicable to captive RRGs. The firstconcern was whether the model regulation requirescaptive RRGs, which prepare GAAP financialstatements for regulatory purposes, to have theGAAP to statutory reconciliation included as anaudited footnote. A task force member noted thatmost captive RRGs do not maintain separatestatutory financial records. It was noted thatstatutory financial records would be required inorder for a CPA firm to audit the GAAP to statutoryreconciliation. Such requirements may be costprohibitive. The task force agreed to discuss thisissue on an interim conference call.

The second concern raised was whether some statesmay be exempting captive RRGs from an annualaudit requirement based on the RRGs premiumdollar amount or number of policyholders. Suchexemptions are permitted for traditional insurers inaccordance with the model regulation; however,under the federal Liability Risk Retention Act of1986 these exemption criteria are not applicable toRRGs. The task force agreed to survey states todetermine whether any states are exempting captiveRRGs from an audit requirement.

The Risk-Focused Examinations Subgroupcompleted its work to develop best practicessuggestions for conducting risk-focusedexaminations of captive RRGs. The task forcediscussed the suggestions and referred the documentto the Risk-Focused Surveillance Working Group forpossible inclusion in a broader practice aid. Havingcompleted its charge the task-force voted to disbandthe subgroup.

***

The next National Meeting of the NAIC will be held inHouston April 6-9. We welcome your commentsregarding issues raised in this newsletter. Pleaseprovide your comments or email address changes toyour PricewaterhouseCoopers LLP engagement team,or directly to the NAIC Meeting Notes editor [email protected].

Disclaimer

Since a variety of viewpoints and issues arediscussed at task force and committee meetingstaking place at the NAIC meetings, and because notall task forces and committees provide copies ofagenda material to industry observers at themeetings, it is often difficult to characterize all of theconclusions reached. The items included in thisNewsletter may differ from the formal task force orcommittee meeting minutes.

In addition, the NAIC operates through a hierarchyof subcommittees, task forces and committees.Decisions of a task force may be modified oroverturned at a later meeting of the appropriatehigher-level committee. Although we make everyeffort to accurately report the results of meetings weobserve and to follow issues through to theirconclusion at senior committee level, no assurancecan be given that the items reported on in thisNewsletter represent the ultimate decisions of theNAIC. Final actions of the NAIC are taken only bythe entire membership of the NAIC meeting inPlenary session.


Additional information

If you would like additional information, please contact:

Jean ConnollyManaging Director, NationalProfessional Services GroupTel: 1 440 893 [email protected]

PwC’s Insurance Practice Leaders

Jim ScanlanInsurance Practice LeaderTel: 1 267 330 [email protected]

Paul McDonnellInsurance Advisory Co-leaderTel: 1 646 471 [email protected]

James YoderInsurance Advisory Co-leaderTel: 1 312 298 [email protected]

David SchenckInsurance Tax LeaderTel: 1 202 346 [email protected]

www.pwc.com/us/en/insurance

© 2012 PwC. All rights reserved.“PwC” and “PwC US” refer to PricewaterhouseCoopers LLP, a Delaware limited liabilitypartnership, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is aseparate legal entity. This document is for general information purposes only, and should not be used as a substitute forconsultation with professional advisors.


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